Dow; Up, Down Or Nowhere

Dow; Up, Down Or Nowhere

By Sol Palha

He who is afraid of a thing gives it power over him.

Moorish Proverb

Thus given the fact that so many individuals are proclaiming a bottom is in the smart money might purposely push the indices down one more time. If this happens we would view this as a buying opportunity. Market Update March 25, 2008

Once again lady luck smiled on us and our prediction came true within days of making it. From a high of 12530 last Tuesday, the Dow dropped to a low of roughly 12180 before mounting one of the largest one day rallies ever. Last week was a perfect example of mass psychology in action; the smart money drove the indices lower and the masses panicked and then a few days later the markets miraculously recovered.

There was no real good news except the perception that the worst part of the sub prime mortgage disaster was behind us. Once again this is only a perception and it goes to show how very important it is for the serious trader to understand the basic principles of mass psychology. Increasingly the emotional factor is becoming the key facet that drives these markets up or down. This emotional factor is gaining momentum simply because the number of players in the last 10 years has exploded exponentially and it’s getting easier and easier for individuals on any part of the globe to trade in the Worlds most liquid markets. Thus it also becomes easier to manipulate these very same individuals because they all seem to tune to the same source for the news or to make matters worse a central theme is repeated again and again on various news outlets and thus the desired negative outcome is achieved, mainly that of convincing the individual that all hell is about to break loose.

To see a miniature version of the mass mindset behind the markets all one needs to do is go to one of those massive blow out sales that are held every now and then by many department stores. You have people sleeping outside and lining up in long lines; one almost gets the impression that these people are a bunch of crack heads waiting for their fix. They line up just because an impression has been created that everyone is going to be able to find a huge bargain; in reality only a few people will find anything of value while the rest will have wasted valuable time that could have been applied to other more important matters. The point however is not who gets what but the question of how they get what they think they need. As soon as the doors open the crowd floods like a lynch mob looking to hang someone; they have absolutely no regard for anyone as they shove and push struggling to get into the store. If you could position yourself somewhere and pay attention to their facial expressions and body language you would be hard pressed to call these individuals human for at this point in time their behavioural patterns match those of creatures from the animal kingdom more than they match those of humans. For awhile everyone has lost touch with their senses as they madly rush to lay claim on a few products that have been steeply marked down.

This very same behaviour is seen in the markets; only this time the trigger point is the smart money. To create a stampede the smart money triggers a mini sell off and the masses react by all starting to sell; this creates a domino effect that feeds on itself. However before this the press lays the ground work for this slaughter by incessantly repeating the same theme over and over again under the guise of reporting news. This is what happened during the sub prime mortgage meltdown. The press as well as the banks concerned knew months if not years in advance that trouble was brewing but they waited till the ship started to take in water before they started to report on this event; report they did with full fury and instead of dousing the flames they poured gasoline on them. However this trick is employed again and again and it works marvellously. Look back at any disaster and read the news that followed; if you black the dates out one would have a very hard time stating if this event occurred a 100 years ago, or just a few years or few weeks ago.

So after the press has done its job the smart money might trigger a sell of or sell offs by say by sacrificing on paper 100 or 500 million (we are just using numbers for illustrative purposes) but the masses drive prices so low that this loss is made up several times over as they are now able to buy at prices that are 30% and sometimes 60% of their highs. When the market rallies upwards the small loss is recovered immediately and the rest is nothing but gravy. Now this same pattern is repeated again and again. The only thing that changes is the strategy when they are building positions they wait for a rally and then kill the rally before it can build legs in order to buy more. Note how well they have been doing this for the last few months. When the markets have rallied for a very long time they start to slowly sell into strength and then sit on the sidelines waiting for the right time to buy again. If you look at history you will see no matter how far back in time you go that the big money was always made when blood was flowing in the streets. The smart money knows this and starts to buy when the streets are over flowing with blood. Panic when left unchecked is a very dangerous force and the punishment for those who let this emotion rule is always painful and severe.

Throughout this correction as we were one of the few out there that refused to call it a crash, we remained bullish as all our indicators, smart money action and the high NYSE short interest ratio suggested that the markets were getting ready to rally again. The excerpts below from past market updates illustrate how we opposed the crowd and stood firm while the situation around looked bleak and ugly.

“Once the transports can break past the 4800 mark and stay above this mark without trading below that level again, this will in turn provide the fuel necessary for the Dow to surge past the 12800 mark. So it would pay to monitor the 4800 zone as it will probably provide an early warning signal that the Dow is ready to break out from its trading range”. Market update March 18, 2008

There is a decent chance that the markets could pull back to the 12250-12300 ranges therefore when this transpires risk takers can purchase yet another lot of options or go long Dow Futures. Market update March 25, 2008

Thus based from our suggested entry point of 12070 to the exit point of roughly 12700 (Dow traded as high as 12740 after we issued our sell instructions) traders were able to lock in 630 points of gains. The Dow has now traded within our suggested re entry points of 12250-12350. Market update March 4, 2008

As we have remarked many times in the past the main reason we started analysing the markets was that it provided an unlimited source of data to improve our understanding of the mass mindset. For when one understand this one can use it all aspects of ones life, one of which happens to be the markets. To break away from the mass mindset is probably the single most difficult task a person will encounter in their life time; most will fail miserably as they will assume they have broken away but when push comes to shove they will fold like a house of cards. The best way to understand what drives you is to keep a journal, especially during times of extreme pain, misery, frustration and Euphoria; these moments of extremes are the ones that truly provide the basis for understanding what drives the mass mind and how to break away from it.

As we mentioned before it appears that the masses are now ready to believe that the worst is behind us in terms of the sub prime mortgage fiasco; whether this is true or false is irrelevant as mass perception is all that matters especially in terms of investing. However we still have a large camp of what we call neutral to undecided investors and this camp is full with both bulls and bears. This is easily reflected in the daily volume of shares trading; for the last several weeks in a row; every rally and correction has taken place on mediocre volume. Take for example the huge massive rally of April 1st; the total volume traded came in at only 4.83 billion shares a far cry from the all time high of 7 billion shares traded a few short months ago. We can deduce two things from this action

1) There is a huge amount of money sitting on the sidelines just waiting to be deployed so this is bullish in the long run. The trigger will once again come down to perceptions as soon as they start to feel good they will jump and buy.

2) The fact that a large group of players are sitting on the sidelines means that volatility levels will continue to remain in the extremely high ranges, simply because the chaps that are playing will be nervous to hold their positions for too long; thus they will constantly jump in and out until new money comes in to suddenly drive the markets out of their range bound action

We also note that for some reason the OEX traders continue to remain bullish and that is still reason for concern on the short term time frames. We did witness one spike in the number of individuals shorting odd lots of shares last week and this is a plus. Another strong bonus is that our smart money indicator continues to diverge every time the market sells off; in the past it almost always confirmed each sell off. Interestingly enough while the Dow was able to stay above its Jan lows, the SP 500 dipped below them in March but in doing so flashed a rather strong positive divergence signal on the daily charts. Even more important though was that the number of lows dropped during this period (this was clearly seen in the 3 moving averages of new lows we maintain) and thus we have another strong intra market positive divergence signal.

The short interest ratio on the NYSE continues to trade in record territory and as we have repeatedly stated in the past no bear market has started with a high short interest ratio. Finally we note that the Dow transports are very nicely trading above the 4800 mark; all that is left is for them to do so for 12-15 days in a row. They are now roughly 500 points away from putting in a new high; for those who think this is not possible consider that in roughly 3 months they have gained over 23% (a low of roughly 3950 to the current price of roughly 4870).

Conclusion

The bottoming action appears to have taken forever and the move up appears to be even more agonizing especially for those who look at the markets on a daily basis. One of the reasons for the very hard correction had to do with the fact that almost all the banks lied about their exposure to the sub prime market. We knew real estate would take a hit but we had no idea that so many well run banks would be stupid enough to sacrifice decades of business savvy and hard work to attempt to make a few bucks by playing with paper that was not even worth in some cases of being flushed down a toilet. What made the matter worse was that no one could have dreamed overseas banks would have been as asinine as the US banks to expose themselves so dangerously to this worthless paper. Any banker with a grain of knowledge knows that one should never lend money to dead beats but in this case not only did they lend to dead beats they over extended themselves by lending to these deadbeats; it’s like you and I lending money to the local alcoholic who has no job. Even if he promises to pay you 20% interest on the money he borrowed from you, what chance do you really have of collecting this money? You could confiscate his booze but if you are not a heavy drinker then you are just stuck with some worthless cheap alcohol.

Due to the high short interest ratio, lack of sell signals and the very bullish signals our smart money indicator is generating we feel that traders willing to take on risk should view every pull back in the 200-300 ranges as a splendid buying opportunity. The options we got into last week yielded results rather rapidly and we did this more as an illustrative exercise. The Dow options do not carry the same risk as the OEX options or as Dow Futures but on the same token they offer smaller gains. Futures traders locked in thousands of dollars in profits while OEX option players in some cases locked in over a 100% in gains.

Extracted from the April 08 Market update

New Comments April 15, 2008

It’s truly amazing how well the transports are holding up given the fact that oil continues to put in new highs almost on a weekly basis.

The normal course of action would be for the transports to plunge given the fact that oil is now trading at a record high of 113 dollars. The transports bottomed when oil was trading at roughly 87 dollars and now that oil is trading up a whopping 30% higher one would think the transports would correct even harder; instead they are putting in a series of very bullish higher lows. The Transports are only 11.6% away from putting a new high; given the fact that they have rallied over 20% from their lows it would be reasonably fair to assume that they are going to surpass this target in the near future.

Oil has put in yet another new high and instead of closing lower the transports after initially pulling back have ended the day up roughly 50 points. As a result the Transports have generated a very strong intra market positive divergence signal. As the markets are forward looking one has to conclude that the transports must be seeing something positive in the near future. Imagine if they are able to hold up so well with record high prices how they will react if oil should mount a minor correction.

The pattern we spotted several years ago suggests that the Utilities lead the way up (they have already done so by putting in back to back new highs in Dec 07 and Jan 08), the next to follow suit is the transports (so far they appear to be on track) and finally the Dow industrials play catch up. Thus based on this and many of our technical and psychological indicators one could go as far as saying that its almost a given that the Dow will go on to put in new highs if the transports take out their old highs.

Whenever we're afraid, it’s because we don't know enough. If we understood enough, we would never be afraid

Earl Nightingale 1921-1989

All charts are supplied courtesy of www.prophetfinance.com