Ask us Anything Answers – final installment

Final Installment of the 4-part Ask Us Anything Answers series answers for 040523. Lots of good questions received through this series! -We’ll do another AMA blog in a few months. Today: Trend reversals, the sentiment cycle, and the tech rally are covered. Plus, a special guest interview announcement!

Trend reversals

Mano asks how we identify a trend reversal. Do we do top down analysis followed by individual stock analysis? Or do we just focus on the broad markets?

We do take a top down approach. Essentially, we look at the market from a trend-analysis point of view first – the rules of which were discussed in AMA blog under the trendline question – here.

We also look at the risk/reward profile of the market via the Bear-o-meter. I just posted my monthly Bear-o-meter reading this week, here. Both of these are part of our decision making process, but trend trumps all.

Beyond those two tools, there are many other factors we go through to assess the market.  Its impossible to discuss them properly in this blog. For example, we look at seasonality, cycles, Fed actions, EWT wave count, Long termed monthly chart patterns including very long termed momentum studies (eg ROC on a monthly chart). We also view neartermed chart activities like candlestick patterns. Obviously, this is too much to discuss in a few paragraphs. I recommend you consider taking my Online TA course to get the entire process. In fact – I strongly suggest you take the course! I promise you that you will not regret the small investment in time and money.

In it, you will learn a step-by-step process to identify the macro, sector, and individual stock pictures you need to know. You will learn how to determine the timing of your buys, and more importantly, your sells. Everything, and I mean EVERYTHING is discussed over a series of bite-sized lessons that you can do at your leisure. Lessons are short (usually 15 minutes or so) – and each general topic incorporating the lessons ends with quizzes  to ensure you have a usable knowledge. You can revisit/re-take the lessons at your leisure.

Anyhow, here is the quick summary – we use macro index trend analysis, followed by the Bear-o-meter factors such as sentiment and breadth to assess the risk. All of this is done within an understanding of where we are within a broad market cycle. Which brings us to the next question!

Sentiment cycle

Harry wants to know where we are within the sentiment cycle that I discuss in the Online Course. Below is the diagram I used in the course for reference:

From a classic sentiment cycle perspective, its pretty clear that late 2021 was the period of euphoria, as shown in the cycle chart above. In fact, if you go back to my late 2021 bogs/ early 2022 blogs – you will see that I was referring to that reality before the bear of 2022 had begun. Typically, you get signs such as low VIX readings, high dumb money vs smart money confidence, and narrow breadth at that stage. That is what I was identifying at the time. One of the reasons I keep my postings live is to allow you guys to go back and check my accuracy. On April 1, 2022, I officially declared a high risk bear alert, but I had been pounding the table about the danger for several months leading into that declaration.

Right now, it appears we are in the lower part of the sentiment curve. It looks to me like we are forming that base that makes a market bottom. Quite possibly, we saw the moment of capitulation, or despair, occurred last October. Like all simple diagrams as the one above, you don’t get to see the noise that constructs the bottoming process. Most bottoms are complex. Meaning, the market swings wildly up and down as the bottom is formed.

I’ve discussed this a lot lately – including references to past bear market bottoms. In the fall of 2008, for example, you got a similar setup to October 2022 on the SPX. But then the market made one final run lower in March of 2009. Still, the resistance neckline at around 950 was established in the final quarter of 2008 – creating a Head & Shoulders bottom pattern. If the same pattern occurs this time, todays neckline around 4100 is the level to watch.

Now take a look at the bottom of the 2000-2002 bear market – chart below. Note that the neckline was established during the late summer & final quarter of 2002. Interesting, this neckline was at around the same level as happened 7 years later (above chart) –  also around 950. In 2002- instead of a big washout like we saw in March 2009 – we got 3 tests of the lows (near 800). The complex bottom formation occurred between Q3 2002-Q1 2003.

I suspect that is what we are going through right now. note the lid at 4100-ish. Note the sideways chop, with October being a low. Is this a Head & Shoulders pattern, or is there another washout still to come? To me, this looks like October could be the head if that is the case, but until 4100 breaks – and I mean convincingly breaks – all bets are off. We could be in for more 3800-4100 zone gyrations before the fat lady sings.

So, Harry, I think we may have seen the capitulation/despair part of the cycle, but I wouldn’t discount the possibility of that thought being incorrect – and for something like March 2009 to happen (a final lower low). Whatever the case, we are somewhere in that lower part of the sentiment cycle, and soon we will enter the new hope arising stage – if we are not already there (isn’t that a Star Wars title?).

Also from Harry: What to do when a chart breaks down after you go long a position. Yup, sh#t happens. If you get caught in such a manner, you need to look at past volatility, and determine if you should just ditch the stock after only a few days (minimum 3)–or wait and see if it recovers over a week or two. Honestly, this is the “experience” side of the equation. And even guys like me (I  have been doing this since 1990) still get pinched here and there. The point I note in the course is, wait three days, but don’t wait longer than 3 weeks, to reverse your trade. That’s my system, anyhow.

Tech rally

Francisco asks what I think of the tech rally. The XLK (chart below) paints the picture. We have a nice setup, but the moment of truth is upon us. Will the horizontal line (resistance) near $150 that has plagued XLK since last August be broken to the upside? Hard to say. Momentum studies are universally bullish – approaching slightly overbought. Moneyflow (bottom pane) is flat – so there is less commitment than in the past when tech was “the thing” to own.

Honestly, I can’t make a call here. If we see a break through $150 that can hold, I’d say its game-on. But I can’t say I’d buy right at this moment. Too much uncertainty until a clear breakout happens.

Final Announcement

Some of you gave me some names of people I might want to interview for the videos. These interviews are by and far my most popular blogs/videos. I really like to land great guests for you. In a nutshell – if you like them, I like them!

Well, thanks to reader suggestions, I have another awesome guest interview. I’m thrilled to announce that I recently interviewed Frances Horodelski – my favorite BNN MarketCall host! We talked markets, sectors and other interesting stuff. What a truly great lady with a plethora of knowledge. Frances has a deep background in finance, and through her media presence, has interviewed enough of us Portfolio Manager types to hear many different perspectives.

Plus, she has a kick-ass blog.

Happy trading!

 

 

 

6 Comments

  • Thanks Keith for answering my question about the methodology behind trend reversal.
    I will wait for a “fire sale” to take your TA course. I did take TA course by CSTA many “decades” ago! Won’t tell you when b/c then you will guess my age! Jim Young was the coordinator then. Larry Berman was a very young man then! There was another Keith…Keith Edwards! I have always loved the charts though I realize how while a picture is worth a thousand words, equally important is the fact that the beauty lies in the eyes of beholder! Being an individual investor, I couldn’t take the CMT exam!
    John Copp CMT is a good friend of mine and he would be an entertaining guest on your show as well. I think your paths may have crossed 20+ years ago? John loves PNF charts and is a fan of Dorsey.
    Mano

    Reply
    • Mano—awesome. First, wow! Jim Young ran a TA course and I attended it when I was studying for my CMT. Were you in my class??This would have been mid/late 90’s…
      John Copp–yes, we have met. Please let me know how I can contact him–would love to have P&F talk –something I am not an authority on–you can even ask him to send me a LinkedIn or via the website on contact us section–he would be a great guest!

      Reply
  • Thank you for answering my questions.I need to get better at selling quickly when I am wrong. Being wrong even three days in volatile holdings like Natural Gas or Bitcoin can inflict a lot of damage. I do volatility adjust my position size but it still can hurt…probably the ego as much as anything.
    Being old enough to remember the 2008 decline the latest correction has felt very orderly, not the capitulation and despair some previous corrections have served up.
    I look forward to your interview with Frances. Thanks for doing your blogs.
    Harry

    Reply
    • Same here… Between 3 days and 3 weeks a lot can happen. I always feel that when I sell quickly, I see the price going back up after just a few days. And when I wait longer, I just sit there and watch it go lower and lower until I sell… at the bottom 🙁 I think selling at loss is the hardest thing to master as a trader…

      Reply
  • Keith A follow up to your XLK chart that ties into my question of disregarding the very highest and lowest points. Could your resistance line have been drawn from the Feb 8 2021 high before the exuberance, then tested in May 2021 through to Jan 30 2023 where $ 138 caused a slight pullback then broke through to todays price?
    Granted this move is meeting resistance at $150 but a break out of $150 would have resistance at $ 170. Or is it as simple as $150 is the last high and until it is bypassed the risk outweighs the reward. Maybe just over thinking and should re read the KISS blog.

    Reply
    • Old levels of support/resistance matter, but they matter less than more recent activity–especially when you see multimple hits around a certain leve. XLK has more hits of late near $150, and that level also happens to be a former support zone (see my long horizontal red line on the chart). So its a powerful zone for the tech sector.
      And yes, you will see other levels of resistance – such as $170 as you note on XLK – whenever you view a stock or sector or market that has fallen, based and broken out. I tend to look at those levels as first targets. You expect some pullback at them. If they fail too badly, time to get out. If they break through–that’s a good omen.

      Reply

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