Wednesday, July 7, 2010

How you could have seen this bounce coming?

Before we start with this post, let's go back to the following from yesterday's post:

"Going through some of the blogs I follow and messages on twitter, I see feelings of frustration beginning to creep in within many traders. I don't wanna sound like a prick here but this is good if you are long! The markets are going to bottom when more and more people throw in the towel. And I see that beginning to happen. I might end up being completely wrong but I still think being long is the high probability play here. Too many traders out there are calling for a double dip and taking out charts from the great depression. All this makes me like the odds of a short term bounce here. And if I turn out wrong, that's what the stops are for."

The markets jumped over 3% today. Was I right or was I right??!! OK. Enough with the gloating and let's get back to business. Actually, the purpose of putting the above paragraph from yesterday's post in was not to gloat, or rather not just to gloat, but to point out how confident I was about this bounce happening in spite of the really frustrating action for the bulls yesterday. Where was this confidence coming from? I thought I would put the various factors behind the confidence in writing for my own future reference, and hopefully it would be of some help to you readers too. Here we go....

(1) After almost 10 consecutive down days, you have just got to prefer the odds of going long to going short. Unless more unexpected bad news keeps on coming, this is sufficient time for the market to price in what it knows. If nothing else, expect an oversold bounce.

(2) 10 consecutive days would tell you not to short here and wait for a consolidation or bounce before shorting. What it does not tell you is whether you should go long here. There are other factors that come in play for that. One is being oversold on pretty much all indicators, including the McClellan Oscillator, the oscillator I have really come to trust in the past couple of years.

(3) Positive divergences were beginning to show up all over the place, both in the volume distribution and advancers/decliners charts. I pointed this out in this post over the weekend

(4) The negative sentiment out there was just getting a bit too much irrational. Too much talk of a double dip in the air and even a lot of comparisons with the great depression. 

(5) All the points above set things up for a nice bounce but there was still a vital factor missing. Too many traders were trying to pick a bottom. Now obviously, with the market's tendency to take the path of maximum pain, a bounce was not going to happen if everybody was calling for it. This changed yesterday. The poor intraday action when everybody expected the markets to go much higher built up a lot of frustration and caused many traders to throw in the towel and stop calling the bottom. And this was the missing piece of the puzzle! The result? A bounce today?

So, the above was the thinking behind my confidence yesterday. Now, if the similar things happen in the future, and I am sure they will, it does not necessarily mean the market has to bounce from there but what it does mean is that the market has a very good probability of bouncing from there. And that's the best you can get in the market. There are no certainties in the market. And if you are wrong, that's what your stops are for. I hope this post was of some help to you readers!

I will be back with an analysis of today's action later in the evening. Take care and good luck!

No comments: