Rally looks to have started, but keep these things in mind if you play it

For the past few weeks, I have been strongly suggesting the likelihood of a “tradable bounce” within the context of a larger bear market trend. However, as noted on my blogs, certain conditions had to occur to pull the trigger on a buy. Even then, I made note that trading a bounce is not a game for risk adverse investors. Today I would like to follow-up on those observations and talk about some of our trading activities at ValueTrend. I’ll also present some interesting studies that may add evidence to further upside in this rally. Again, this is a probabilities game. Mind your stops if you trade this rally. Things can change quickly!

Below you will see the spinning tops/doji’s and the hammer that I spoke about in my May 19th blog. I noted  then that they shouldn’t be acted on unless we get follow through (positive days). We did get some follow through last week. OK, in we went with an initial position – more on that below. My target, should this rally continue, is at near the 200 day Moving Average. Understand that a declining trend like we have witnessed since January will push the 200 day SMA into a downtrend. As such, the SMA is a “moving target”. The farther forward in time we go, the lower the average will go for the time being. Right now, assuming a rapid rally, we might see near 4400 as a target. It cold overshoot that – or undershoot. Or, this rally may fail and we get stopped out. This is trading, folks. Here’s the chart:

ValueTrend’s actions

This is not trading advice, nor a recommendation. I am merely recounting our actions as Portfolio Managers during the past few weeks to give you an idea of how we are attempting to play this potential rally for the Equity Platforms we manage. During the week of May 16th, we witnessed a potential setup for the bounce. On the 19th, I noted on my blog that we needed a follow-up in order to begin stepping in. Admittedly, we had taken one small step into the market prior to the follow-up days by investing 2% of our cash into a technology play. By early last week, we were starting to see confirmation  (up days) of the two spinning tops and single hammer formation noted from the week of May 16th’s activities on the markets. We stepped in by another 6% on the Wednesday and Thursday morning (25, 26th) of last week. Keep in mind that we are coming into this period with quite a bit of cash. So even with this activity, we remain somewhere near 20% cash. And remember, we are more than willing to reverse our trade and go back to cash if we see strong weakness come back.

Observations of late

If you have not read my latest book, Smart Money/ Dumb Money – I might encourage you to do so. Hey, I make something like $4 if you buy one from Amazon, so it isn’t exactly my get-rich-quick scheme. I want you to read the book because it covers my macro analysis system -which encompasses the subject of contrarian investing. In the book, I look at many interesting indicators not often discussed on this blog. BTW–please write a review on Amazon if you have or do read it. Thanks.

Below are a few of those signals, plus a sampling of some other indicators that I only occasionally look at. All of these signals are pointing bullishly towards a rally. Keep in mind, though, that the bigger trend remains bearish. I am merely presenting factors that may enhance the chances of the candle formations we saw a couple of weeks ago to be accurate in their neartermed rally signal. Here goes. Buckle up!

Insiders buy/sell ratio

Sentimentrader.com shows that when insider buying vs selling reverses from a negative ratio to about 1.2:1, markets rally (historically) 100% of the time in the next month

Insiders buying velocity

I noted in my last Bear-o-meter update that smart money was buying while dumb money was selling this market. That indicator was one of the factors that gave me a heads up to start looking for the candlestick formations that might imply a rally. Part of the “smart money” part of the smart/dumb indicator is insider trading. Sentimentraders shows us that when the velocity of their buying picks up, markets tend to go up. That’s happening now.

VIX

The VIX hit my trigger point of 35- meaning market participants have been  “too fearful” lately. That’s a strong and highly reliable buy signal.

NAAIM exposure

We like to think that we at ValueTrend are a little ahead of the curve over the majority of Portfolio Managers. We’re actually pretty good at managing volatility. Our long termed results through many corrections and outright bear markets offers evidence of this statement. Fact is, most Managers don’t outperform the market, nor do they reduce volatility much better than a buy/hold index investor. They often go in and out of the market and raise/lower cash/equity exposure with timing almost as poor as individual retail investors. As such, they are part of the dumb money side of the Smart/Dumb indicators. We recently witnessed a rush into cash by the Investment Manager community after markets had fallen. Impeccable timing – right along with their retail client counterparts. This is a buy signal – see the chart below with my horizonal  “buy” line signal (bottom horizonal line).

New high/Low on NYSE

This is a breadth indicator that can also be used as a form of market participation momentum. I use it as one of the factors to calculate my monthly Bear-o-meter readings. It went into oversold territory recently, and that inspired us to be on the lookout for a neartermed rally.

University of Michigan Consumer Sentiment

Finally, we have an indicator that only came into my universe of  things to keep an eye on about a year ago. There is about 20 years of data on this chart, which takes us back to the 2008/9 bear market. Consumer sentiment fell hard back then, and the indicator went to extreme lows. We are not there yet, yet its close! If history repeats, we may be in for a bear market bottom, based on this indicator, within a few months – assuming consumer sentiment remains low or goes lower. I don’t have huge confidence in this in timing a neartermed rally, but I thought you would like to see it for the big picture.