Financial Sense   Home  l  Market Monitor  l  Market WrapUp  l  Storm Watch  l  About Us  l  Contact Us

"The Importance of Identification"

"Correct identification of present market conditions is more important than forecasting how they may change in the future" 

Quite often investors are paralyzed and unable/unwilling to take a position in the market, because they "can't forecast" where the market is going next. In my 14 years of being a student of the markets, I have found that being able to forecast accurately what changes may take place in the future is definitely a plus. It is NOT a "must" in order for one to be a successful investor/trader. In my view, being able to identify accurately the forces that are exerting influence on the market at the present time is a "must." The reason is simple. As long as we can understand the prevailing market climate, we don't really need to know--although it makes things easier if we do--when the climate will change. When it does, we'll identify it and act accordingly. In other words, investors should be more concerned with whether market conditions are favorable today, than whether they will continue to be favorable three months later. As long as we can identify the change in present conditions, in a timely manner, we can always adjust our strategy accordingly. 

Over the weekend, I read plenty of commentary suggesting that last week's action meant that the "character of the market" had changed, is changing or was about to change. However, none of the commentary offered a "benchmark" by which we can objectively conclude that indeed a change in the market's character is taking place, and thus, action may be needed.

Three Conditions for an Intermediate Term Rally End

Continual Absence of Adequate Buyers

In my opinion, last week's action was characterized by only one of the three conditions that need to be present in order to conclude with a reasonable degree of certainty that an intermediate term rally has come to an end.  The first condition that needs to be present is a continuous absence of adequate number of buyers to absorb available supply. This condition can be easily observed thru the market's repeated inability to sustain rally attempts, resulting in sharp losses during the last hours of trading. Usually, this is our first visible clue that a rally may have run out of fuel, which should put us on alert to look out for the emergence of the other two conditions:  negative liquidity and price making both lower lows and lower highs. It should be kept in mind, that the mere absence of adequate number of buyers to absorb supply at a particular price level doesn't mean that there aren't enough willing  buyers at another price level, which may be lower than the present one, but still  within the existing uptrend.

For example, take a look at the chart below. It is defined by support in the 960-965 zone and higher highs. Buyers may not be willing to step in, in the middle of the range, but they may at the bottom of the range. Consequently, just because we observe a lack of buying interest in the middle and upper end of the range at the present time, it doesn't  automatically mean that the rally is terminated. It could very well be, that the market needs to test support one more time, in order for buyers to step in. Therefore, it would be rather premature to proclaim that the market has changed "character" simply because buyers didn't show up for four days! The chart below is not a forecast. It simply illustrates what could happen:

Negative Liquidity

The second condition, we look for, is negative liquidity. To determine whether liquidity is positive or negative, we look at our Buy/Sell Pressure Comparison charts (see charts below) to see if selling pressure consistently exceeds buying pressure. At the present time, although buying pressure is decreasing and selling pressure is increasing, the bottom line is, we don't have a cross-over yet. If we do not have a cross-over, by definition, the character of the market has NOT changed, therefore, it is premature to conclude that the rally is over. Major market tops do not occur at a single point in time. They are processes. The market could very well be in the process of topping out, but until we have a negative cross-over, indicating that there is more money leaving the market than money coming in, we have no legitimate reason to conclude that the topping process has been concluded and the market is headed lower.

Price Confirmation of Lower Low and Lower High

The third condition that we need to observe is confirmation by price in terms of a lower low and a lower high. For example take a look at the two charts below, depicting the SP as of Friday's close and two possible scenarios that may follow. As of Friday, the SP is in the middle of its recent range, we have no way to conclude with certainty that this range represents either a high level consolidation or a top. To arrive at an factual conclusion, we need to see either higher lows/higher highs or lower lows/lower highs. Notice the difference between the  price action within the two blue lines on the first chart and the price action within the two red lines on the second chart.( the first one resulted in a break-out, the second one in a break-down)

In conclusion, last week's  poor market action caused by clear absence of buying interest, gave us a credible warning sign that the market may be undergoing a genuine change in character. But it gave us no proof as of yet that the change indeed has taken place. The proof will come when we have a negative cross-over between inflows and outflows, accompanied by a lower high and lower low in terms of price. To be specific with regards to the SP, if in the next few weeks we got a negative cross-over; while the SP fell below 960 and failed to rally above 1040, such action would constitute irrefutable proof that the rally is indeed over and the best opportunities are on the short side.

Last week's action  allows us only to speculate that the rally may be over, but it didn't give us any factual proof  that would allow us to successfully defend our hypothesis

Home  l  Broadcast  l  Market Monitor  l  Storm Watch  l  Sitemap  l  About Us  l  Contact Us