Ian Woodward's Investing Blog

Mailbag Question: Dear Scottish John, not only haven’t we run out of time for #2 but hasn’t Mr. Market failed to fulfill most of those clues?  Therefore, shouldn’t we “Otherwise consider anything less as a Bounce Play and expect a retest of the lows.” Regards and much thanks, dave (If you didn’t know it, Ian is Scots for John.)

       

• Please refresh your memory with the targets I set for the Bear Market rally to be more than a Bounce Play in an earlier blog with the same picture written on July 19, three blog notes back…which Dave is referring to. 

Hi Dave:  Move to the head of the class, your beady eyes have seen that SO FAR this is nothing but a Bounce Play and a failed Rally, and therefore as of right now the key sentence you plucked from my note is where the odds stand as of today, and the full answer should come next week; so your note is very timely.  Always have three current scenarios: 

1. The Market goes down to retest the lows and the Bears are in command
2. The Market hovers around sideways and then either goes up or down
3. The Market is still oversold and the Bulls feel it is time to try again, since the Bears have not collared this by the scruff of the neck this past week. 

• My point is nothing is ever cut and dried. Next week should tell us which way the wind is truly blowing, although it points to #1.  The reason I hesitate is that the INTERNALS of the market relating to Accumulation/Distribution have improved both for the Industry Groups and the Stocks themselves since July 19.
• When a Market is so oversold as this one is, the tide goes out so far that most boats are still stuck in the mud, and it sometimes takes a pull back and a second effort to take off on a rally…that is why 50% of the Follow Through Days (FTD’s) fail on the first attempt and then move up on the second shot.
• This is especially true in a Bear Market. It needs a one-two punch from the Bulls to drive it up, while at this stage of the game the Bears only need one punch from here to drive it down.  Net-net, the Bears have the upper hand after two weeks of trying by the Bulls. 
• That should give you enough to chew on for an immediate response, but I will give you more in a blog I will put up over the weekend, which will show you the good stuff “Under the Hood” that makes me hesitate to say the “Party is Over”, period.  Since this note is buried in the comments section, I will resurrect it in its entirety to full view and repeat all this and add more in a fresh blog.  As promised, here is the picture of the good stuff “Under the Hood”.  Let me first set the context in which this picture gives a perspective of where we are regarding a successful or failed Bear Market Rally.  This coming week should determine the outcome.                         
•  

The Color picture shows very well the phases of red, yellow and green in the Industry Group and Stock Distribution turning to Accumulation as depicted by the Columns showing Group A to E, and Stocks with Accumulation from A to E. 

1. The cycle starts when the market has peaked and we begin the downward slide, depicted by Bingo signals showing the RSI (14 periods) dipping further and further down below a reading of 30 on the NYSE.
2. Ultimately, the Market will find a bottom, and this is usually signaled by a final Bingo which is called the Capitulation Day in which the number of New NYSE Lows give a major spike from previous readings. 
3.  In this case the number of New Lows shown is the number of stocks in the HGSI Software Database, but to all intents and purposes you can see that the number of 1019 is almost double that than the previous day and it falls off dramatically the day after that.  One can’t help but notice the spike, and that is the first sign that the Bulls have thrown in the towel when it is a day of fear, and the VIX rises dramatically, usually spiking to a high.
4. Invariably, the day’s Low will be a long spike down (a Tail) on the candlestick with the Market Close finishing much higher as the market decides to rebound.
5. If there is a true rebound then this Capitulation is quickly followed by a huge Reversal Day where the Nasdaq will deliver at least a 2.2% up day in Price gain, and in this case it was 3.1%, as shown on the above spreadsheet.
6. Once we have a Reversal Day, the next item to look for is a Eureka Signal which shows the Bulls are in earnest and demonstrate “irrational exuberance” by clocking up at least 3:1 advances versus declines, 5.4:1 in Adv Vol to Dec Vol, and an ARMS reading of <0.6 on the NYSE, which as we all know is very bullish.
7. These Eureka signals invariably appear within 12 days of the Reversal Day and there are at least two or three of them for good measure. 
8. Meanwhile, we also keep a beady eye out for what has become known as the Follow Through Day (FTD), where the Nasdaq again delivers a strong up day both in Price and Volume.
9. My work has shown that the “odds” of a FTD being successful is no more than 50%, i.e., a toss of the coin, and this is especially true in a Bear Market.
10. As I show above, any distribution day that occurs within 5 days after an FTD diminishes the probability of a successful follow through day.  My thanks to Mike Scott for this information.
11. After day five following an FTD, the probability of success increases if there has been no distribution and as the picture shows, we will not have reached that state until Tuesday of next week.
12. The final and most important requirement for a successful FTD is the need for the NYSE New Highs to get above 100 and then stay above 150 while the New Lows diminish to less than 50 (say). 

Nothing in the Stock Market repeats itself consistently, but these are rules of thumb that over the past eight years have proven fairly reliable.   I have given you a step by step recital of the process and shown you a picture to help you along.  It is not that complicated as the net-net message comes down to a few basic points: 

1. After a Capitulation Day expect a Reversal Day, and then a Follow Through Day within three to nine days. 
2. Once you have a FTD, there should be no distribution days for five days thereafter.
3. Eureka signals should register within 15 days of a Capitulation Day and if not the rally must be regarded as suspect.  New Highs on the NYSE must exceed 100 to 150 while New Lows go down rapidly to less than about 50.    

If any of these rules are violated it is probably a failed rally, and little more than a Bounce Play that will invariably end in a retest of the recent low to provide a double bottom or worse yet searching for a lower bottom.  As my friend Dave reminds me a strong clue that all is not well, particularly at this time of earnings reports, is when stocks deliver strong gains but there are failed breakouts galore or the stellar results are ignored and the stocks are pummeled.  The worst clobbering occurs when the results are reasonable but the guidance for the following quarter and/or year is lowered.

 

Best Regards, Ian.

 

 

This entry was posted on Saturday, August 2nd, 2008 at 8:03 am and is filed under HGS Principles, Market Analysis. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.