Monday, May 24, 2010

How to Trade Market Bottoms for SP500 & Gold

The stock market topped in April which was expected from analyzing stocks and the indexes. Back in April I posted a few reports explaining how to read the charts to spot market tops. Today’s report is about identifying market bottoms. It does not get much more exciting than what we have seen in the past 2 months with the market topping in April and the May 6th mini market crash. This Thursday we saw panic selling which pushed the market below the May 6th low washing the market of weak positions.

For those of you who have been following me closely this year I am sure you have noticed trading has been a little slower than normal. This is due to the fact that the market corrected at the beginning of the year and we went long Feb 5th and again on Feb 25th. Since then the market rallied for 2 months and never provided another low risk entry point. In April the market became choppy and toppy and we eventually took a short position to ride the market down. Now were we are looking at another possible reversal to the upside.

Only a few trades this year which I know frustrates some individuals but if you step back and look at my trading strategy you will learn that we only need to trade a few trades a year to make some solid returns. I don’t know about you but I would rather trade a few times a month and live life between trades… not trade all day every day getting bug eyed in front of the computer.

Ok enough of the boring stuff let’s get into the charts....

SP500 – Stock Market Index Trading ETFs & Futures
The pullback in the broad market was expected but the mini crash on May 6th really through a wrench into things for us technical analysts. We don’t really know the truth about what happened that day… was it just a simple error or was it a planned error for the US government to take a massive short position to move something in their favor quickly to generate MASSIVE gains? It leaves us technicians hanging wondering if that was a shift in trend from up (accumulation) to down (distribution)?

My thoughts are if the crash was truly an error then we will see months if not another year of higher prices… But if it was a planned sell off with banks moving to the sidelines then we are most likely headed into another bear market. Personally it does not matter what happens as big money will be made in either direction. Problem is if we do go into another bear market then the majority of individuals will lose capital as investor’s portfolios get smaller and smaller. That will lead to a lot of depressed people…

In short, I am neutral on the stock market for the intermediate and long term. Once we have a few more months of price action only then will I have a plan for longer term investments. But on the short term time frame the market is screaming at me with extreme sentiment levels lining up on the stock market and gold.

The daily chart of the SPY – SP500 Index shows several important points which help me time market bottoms. We have prices trading at a support zone. Buyers step back into the game here and should provide a decent bounce which started Friday Morning.

Next we have the panic selling spikes from an indicator I created. Generally the day after we see panic in the market like we did on Thursday we will see a big bounce and many times a large rally.

Down at the bottom you can see my custom market cycles which are both starting to bottom. During times like this the market has a natural tendency to move higher.

VIX – Market Volatility Daily Chart
The VIX has an old saying “When the VIX is high its time to buy, When the VIX is low, its time to go”. Simple analysis clearly shows the VIX trading high and at a resistance zone.

Put/Call Ratio – Daily Trading Chart
This chart measures the amount of put and call options traded each day. When it is trading over 1.00 then we know for every 1 call option traded (wanting the market to go up) there is 1 put option traded (wanting the market to go down). Over 1.00 is extreme and when that many people are bearish and using leverage to profit from a drop in price then in my opinion it means everyone has already sold and the selling pressure is about to end.

Actually if you go back in time and review SP500 and this ratio you will notice 2-3 days after this ratio reaches 1.00 or higher the market bounces/bottoms.

NYSE Advance/Decline Line for Equities – Daily Chart
This chart shows us how many stocks are advancing or declining on any given day. When extremes are reached look for a short term bounce or bottom 1-3 days following.

How to Identify Stock Market Bottoms with Simple Analysis:
In short, I feel the market is forming a bottom here. How big of a rally will we get? I don’t know because of the mixed signals from the May 6th EXTREME heavy volume selling session. As usual I focus on trading with the trend, trading the low risk setups and I manage my money/positions scaling in and out of those positions as I see fit.

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