Drinking the Kool-Aid and it’s Potent!

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A couple weekends ago, I suggested that we had likely saw the end to V-shaped bottoms. I could not have been more wrong in that presumption; however, was quickly able to adapt as I mentioned last week in my SassyMusings post. Not only did I adapt, but I went from being short-term bearish to bullish even after already being overbought on some measures.

What’s next for market Sassy?

It would be easy for me to assume caution here at all time highs given a straight move up after nearly a 10% correction and who would really blame me? In fact as you continue to read below you will even see evidence as to why I should be very cautious. However, as I mentioned last week I did drink the Kool-Aid and it is very strong leading me to believe dip buying is absolutely in fashion and any small pull-back is a gift.

Why do you think caution would actually be warranted Sassy?

If you follow me regularly you will know I often use SPX 20-day highs as a measure of overbought/oversold readings, but also to measure how broad based market participation is when we make new highs. For about a year we would continuously see new highs without 20-day highs getting over 50%. Friday 20-day highs went to about 60%. The last time we saw it over 60% was September of 2013 after moving 1% above previous highs. Right after that we had a 4.8% pullback. That was also the last time the McClellan Oscillator reached 80%, which just registered twice in the last week. Based on history, this anomaly would suggest an imminent pullback as highlighted by @andrewunknown here. In the last two years (since V-shape corrections have become the rule of thumb) we have had five occasions when 20-day highs went over 50%. Two of those occasions the rally continued to new highs, two had imminent pull-backs. Given that we have registered extreme overbought conditions twice in one week and 20-day highs reaching over 55% gives more credence to a very near term pull-back; however, as mentioned the Kool-Aid has intoxicated me. Thus, I believe the 60% reading of 20-day highs (after over a year of its absence) finally confirms how broad based the recent rally has become and will therefore lead to the next leg of this rally.

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Screen Shot 2014-11-02 at 9.43.41 PMSassy, given the evidence, why are you then expecting a continuation of this rally?

I am going to make this part very short and sweet. You ready?

  1. Psychology/Sentiment: As far as I can tell most traders were caught off guard from the strength of this recent V-shape rally  and now, with good reason, feel it’s a bit too late to chase. This tells me it is in fact the correct move.Screen Shot 2014-11-02 at 9.11.53 PM
  2. Trend followers: Trend followers tend to add at highs and now that we made a new all time closing high on Friday, trend followers should step in.
  3. As mentioned above, 20-day highs are confirming new highs after taking a full year off (previously they offered divergence worthy of caution).
  4. Previous V-shape reversals from oversold readings in the last couple years have went on to make highs. This recent correction was larger and more oversold than any other in the last two years. As anecdotal as this may sound, I can see the rubber band now stretching just as extreme in the other direction leading the market to a higher high that is larger than previous reverals as well as becoming even more overbought than typical.
  5. Seasonality – no need to elaborate.
  6. The unexpected rally has left many people on the wrong side and short-covering still provides a catalyst to continue higher.
  7. Rotation, rotation, rotation – no need to elaborate.
  8. Institutional underperformance – no need to elaborate.

Just give me the main take-away Sassy?

The main take-away is BUY THE F*N DIP. Looking at the open interest of SPY for next week I see support at 198 first and then 196. Below there and I think I will need to write a mea culpa in my next SassyMusings. For a better understanding of using open interest for trading see herespy.10.31

 

Good luck next week. For AMAZING market commentary and intro-day/week set-ups subscribe here.

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