It’s Not So Different

  • August 5, 2002
  • Dave Floyd

What
started off as a promising week for the bulls,
ended with the bears taking back ground as economic data showed the economy is
not as strong as some had expected. Naturally if you read or listen to quality
analysts this will be no surprise to you.

Let’s not forget that a bubble just burst and for anyone to think that we will
work out the excesses in the matter of a few months to a year is truly kidding
themselves. I have found it interesting that in the last few weeks Federal
Reserve, Treasury and White House spokespeople have been all over the Dow Jones
Newswire proclaiming how solid everything is in both the economy as well as the
stock market. 

Sounds like two things to me: 1.) a little fear in the halls of government and
2.) the potential for more downside price action. Naturally none of this is good
longer-term, albeit trading has been incredible, but the fundamental foundations
of the market could and probably will be tested in the weeks to come.

Market history clearly shows that bear
market rallies can be very convincing and big. The following excerpt is from
Adam Hamilton of Zeal Intelligence, it
spells out with history as its basis how our current situation is not so
different from those in the past.

Since the ugly NASDAQ crash of March
2000 there have also been six primary intermediate bottoms and subsequent
rallies.  Undisputedly, five of these great rallies were simply deadly bear
market rallies that helped lure more unsuspecting capital to its doom as it was
utterly destroyed between the razor sharp teeth and gruesome claws of the
famished bear.  The only open question remaining is whether rally six proves to
be yet another deadly bear market feint or the glorious birth of a new bull
market.

Provocatively, the average gain of the six major rallies we have seen since the
NASDAQ crash is 28.5% as of market close on November 20!  As you recall from
above, the six major bear market rallies in the DJIA after the Great Crash
witnessed an average gain of 29.3%.  It never ceases to amaze just how close the
present tracks history and how little really changes!

Why is that?  Why does seemingly ancient history matter so much for analyzing
current markets?  The answer, of course, is that psychology is the single most
important driver of short-term market performance.  (For comparison, realize
that earnings and cash-flow fundamentals are the most important drivers of
long-term market performance.) The endless ebbing and flowing of market
psychology never changes.  It was important 100 years ago, is very important
today, and it will be important 100 years from now.

While the long-term market oscillates around the ability of companies to earn
profits for their owners, equity investors, the short-term market is driven by
the human heart.  Human hearts are just as full of greed and fear today as they
have always been in the past. 

When greed rules the roost, speculative manias such as the 1999-2000 spectacle
occur and market prices are driven to nosebleed heights where they completely
detach from reality for a short time.  As mania psychology peaks, the bubble
markets soon stop accelerating upward and are dragged down under their own
crushing weight.

Following episodes of widespread naked greed, raw fear takes hold, and people
sell equities with reckless abandon initiating a downward spiraling vicious
circle in which lower prices continually begat even more selling.  These greed
and fear-driven oscillations of the market are the single most important
responsible factor for short-term market action.

In bear market rallies, the fear caused by the preceding sharp fall is replaced
by powerful, consuming greed.  Wall Street, investors, and speculators, most of
whom are biased in favor of rising markets, see a small bounce, they assume the
bottom is in place, so they start buying stocks, and a mighty bear market rally
ensues which quickly feeds on itself and grows larger.

Interestingly, the biggest daily rallies in market history in percentage and
absolute point terms occur in the midst of raging bear markets.  The best
performing NASDAQ days in history did not happen before March 2000 while the
bubble mania still lived, but during the two massive bear market rallies in the
first half of 2001.  Bear market rallies are almost always extremely impressive
and compelling!

As indicated earlier in the column, I
suspect that the recent volatility will continue.  Many people ask me, “How do I
know when the trading really good just by eyeballing a one-minute S&P futures
chart?”  The answer is, “Between a trough (pull-back) and the peak there needs
to have been at least a three point range.”  When this range expands beyond
three points, the market is getting active and it is possible to maneuver in and
out of positions safely.  The two charts below show just how “off the charts”
the current intraday ranges have been, sometime as much as 10 S&P points.  It is
in this market that a daytrader can thrive.  As long as this continues, take
full advantage.



Looking at longer-term setups based on
daily charts over the weekend, it was no surprise to see far more short
candidates showing up than long candidates.  Regardless of the trade you may
take, always use a protective trailing stop.

Potential Long
Set-ups:

El Paso Energy (EP)

General Electric (GE)

Johnson & Johnson (JNJ)

Merck (MRK)

Potential Short
Set-ups:

Bank of America (BAC)

Costco (COST)

Dow Diamonds (DIA)

KLA
Tencor (KLAC)

Microsoft
(MSFT)                                                                                                          
                      

Key Technical
Numbers: (futures)


S&Ps
Nasdaq
882.66    923
877.83   917 (key)
927.75  907.75
875     898
867.58  887 (key)
858.60
(key) 		 879
849  865
839      857

As always, feel free to send me your
comments and questions. See you in
TradersWire.


David