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Wednesday, July 15, 2009


Big Squeeze Trend Day

Despite the breakdown, the May 15 low at 879 has continued to hold on a closing basis. That's 4 straight days now the SPX has closed between 879 and 882. If the powers that be can continue to defend this level, those who have shorted based on the now widely reported Head & Shoulders pattern may get squeezed.

VoilĂ ...

The VIX got within 0.07 points of the rally's closing low from 2 weeks ago. If it can make a higher low here and then break last week's high to reverse the downtrend, that would be a bad indication for the market. However, if it breaks down below the rally low, there could be more short squeezing ahead.

And more short squeezing we got today after the VIX made a new closing low yesterday. Today, it broke the intraday low from the rally and made a new low for the year, as the market had its biggest up day in a while.

Amazingly, despite the major market indices closing up around 3% or more, the VIX actually also closed higher by 3.5%, bouncing off its lower Bollinger Band intraday. When both the market and the VIX move up significantly on the same day, the market tends to pull back in the short term.

As shown in this chart, today was the first 9-1 up day in nearly 2 months, while we've had 3 different 9-1 down days in the last month:

If the selloff is over and we're headed much higher, we should see more 9-1 up days and fewer 9-1 down days in coming weeks.

Here's the updated chart including today:

So we did get another 9-1 up day only 2 days later, and this one was actually a 28-to-1 up day. This is a positive sign for those who think the correction's over and the market's going much higher.

Looking ahead, there's some SPX resistance nearby, but the big "Confluence of resistance" remains in the 927-930 area. If the market can break through that area, there could be a further squeeze rally from there -- there may be lots of new shorts based on the media reports on the Head & Shoulders pattern. If the pullback after this bounce holds the 879 area on a closing basis, that could confirm a bottom to this selloff, but if that area gives way, we should see some significant selling to potentially much lower levels. The nature of the follow-through to today's rally will help determine the next big market move.

The SPX basically blew through all resistance to get to the 927-930 "Confluence of resistance" area today. It paused at 927 at mid-day, but then powered through the resistance to close at 932.68, at least partially powered by short covering.

Today's reversal on the VIX from a new intraday low on the year at its lower Bollinger Band to up 3.5% may portend some short-term weakness/consolidation, but if the market can hold the 927-930 "Confluence" area on a closing basis during this consolidation, that would be extremely bullish, and then shorts should be prepared for some more squeezing. If the SPX rallies a bit more in coming weeks, the 13-day EMA should cross back above the 34-day EMA for a buy signal, and if it breaks out above June's high, it will invalidate the Head & Shoulders pattern.

On trend days like today, perhaps the best daytrading tactic is to buy the dips (or sell the spikes on a down-sloping trend day). One of the first programs in our new automated futures trading system was designed to do exactly that, and it has been amazingly consistent, with over 90% wins. Here's the equity curve for this program on the e-mini S&P 500 futures since March 12, when the June contract started trading in volume:

Note that the first couple of months were backtest results on historical data only, but the results since then have been just as consistent or better. While it doesn't need a big trend day to trade (it's traded at least once every week during the testing), it tends to have multiple trades and big wins on days like today.

These results indicate that it's much easier and more profitable to trade with the trend than to try to fight it. Especially on a trend day, it's much easier to go with the flow than to try to predict a turn.

This chart shows some indications to look for to identify a trend day:

On a trend day, you'll see few or no significant TICK readings in the opposite direction (more than 800 negative, or positive on a down day, on the $TICK chart), greater than 9-to-1 up volume vs. down volume (above the blue line on the top green $NYUPV:NYDNV chart, or the second red chart on down days), and a $TRIN reading below 1 and trending lower. On these days, the market will move higher or lower in a trend without significant moves in the opposite direction, and will usually close at or near the highs (or lows) for the day.

You could make significant market profits trading trend days only, if you go with the flow. Remember -- the trend is your friend (until it ends).

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