An Encouraging Reversal of Fortunes ~ The Risk Averse Alert

Thursday, January 15, 2009

An Encouraging Reversal of Fortunes

I am bummed. I should have published on January 2nd and announced a two week vacation! Having sold long Ultra ETF positions that day — locking in gains made from late-November — the year would have begun on a positive note.

This, indeed, was what I intended. Unfortunately, I misinterpreted the market's underlying technical strength. Fearing it might be signaling the market's imminent melt-up, I jumped back into long Ultra ETF positions on January 7th.

And it's been downhill ever since...

Nevertheless, I meant what I said on Tuesday. If I might review...
"Sure, it would be nice to be on top of every twist and turn the market takes. Yet that's not what I'm cut out for."

"Having some better sense of the big picture will in the end still result in a less than perfect trade record."

"Trading ETFs in increments generally is good practice. I didn't this time and I wish I had."

If I had applied just half my investment capital reestablishing long Ultra ETF positions on January 7th, I certainly would have eased in the other half at today's bottom.

Two observations I made today on my Mr. Market Twitter would have encouraged me to pull the trigger. Both confirm the outlook I suggested possible on January 2nd...


First, per my observation on Big Board volume... For 3+ months the NYSE Composite more or less has been range-bound. Each new trip to the low end of this trading range has been accompanied by diminishing volume of shares exchanged. This indicates "selling exhaustion" and supports the case for a pending market melt-up.

The Elliott Wave count you see above is by no means set in stone. Nor, indeed, is the prospect for an imminent sharp advance. Yet a rise above this year's high? I believe the odds are quite good.


Now about my Mr. Market Twitter observation regarding the VIX. There have been periods over recent months when the velocity of the ascent in VIX RSI was notably accelerated.

Now, this might seem abstract, but the usefulness of this observation is rather simple. To wit this condition seems to signal some significant imbalance — some chaotic "weakness" in the character of the market's players en masse — that's typically exploited to bring about a reversal of fortunes.

So, it is indeed good to see this condition being demonstrated during the present, fear-ridden moment ... at the very point in time when I am expecting a spectacular reversal higher.

NYSE 5-min

One other observation I made today was regarding 5-minute RSI presenting "the face of a bear trap." This, I submit, is demonstrated by the many sharp breaks to the sell-side RSI has made over the past couple weeks (noted above by blue dots). More than indicating some overwhelming wave of selling, it seems buyers simply stepped away and allowed sellers to have it their way. Indeed, yesterday, the ratio of down volume to up volume at the day's worst point was incredibly lopsided.

Recently, I remarked on the matter of RSI extremes. On the sell-side these occur at readings under 20 and on the buy-side at readings above 80. When these extremes are reached a reversal of fortunes typically is near at hand.

However, it seems this view might need broadening. Just this week, twice RSI has reached a sell-side extreme. Likewise, both today and last Wednesday (1.7.09), RSI fell right to the doorstep of an extreme sell-side reading.

So, is there something faulty with my observation linking RSI extremes to near-term reversals of fortune? Or is there something about the character of certain Elliott waves making RSI behavior (such as has coincided with the market's recent decline) fitting?

Look again at the daily chart of the NYSE Composite over the past six months. You see I have labeled the recent decline wave c of b.

A "c" wave is a third wave ... typically the most dynamic of Elliott waves. Thus RSI extremes might rather be expected during their formation.

Looking forward, the market's anticipated melt-up is, itself, expected to be a "c" wave. So, should there be any surprise, then, today's strong, upside reversal brought 5-minute RSI to a buy-side extreme?

That said, though, I am by no means pounding the table claiming bottom to the market's decline is in. Still, circumstance I have been waiting for all week — RSI rising above last Thursday's best level — finally has come to pass. Thus, the increase in buying interest we should want to see prior to the market moving strongly higher now is in place. Here's hoping, then, the market's much anticipated reversal of fortunes is, indeed, at hand...

Fast Money
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© The Risk Averse Alert — Advocating a patient, disciplined approach to stock market investing. Overriding objective is limiting financial risk. Minimizing investment capital loss is a priority.

Analysis centers on the stock market's path of least resistance. Long-term, this drives a simple strategy for safely investing a 401(k) for maximum profit. Intermediate-term, investing with stock index tracking-ETFs (both their long and short varieties) is advanced. Short-term, stock index options occasionally offer extraordinary profit opportunities when the stock market is moving along its projected path.

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