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When I thought out loud about the strange market behavior of last Thursday, I pointed out the linkage with the carry trade. I’m a bit puzzled why I haven’t read that anywhere else. If you know of this issue being raised, please drop me a note with a link to where it was discussed.
Everyone has an explanation but in the end I don’t think we will definitively get to the bottom of what exactly caused Thursday’s vacuum of buy orders. In any case, rational analysis is interesting and fun but at the end of the day we are traders. Towards the end of my analysis I wrote (Stepping Into An Empty Elevator Shaft):
I would be looking to lean the other way into the Yen, Japanese bonds, US bonds and equities (for a very quick trade).
That was good for a very quick flip as things ‘normalized’ - thanks to the jaw dropping $955 billion EU bailout. Answering whether this is good for anything more than that is a bit trickier than relying on instinct.
Last week we saw two 90% down days and today’s gap and scream higher will most definitely provide a 90% up day. So we have the makings of a significant floor here as per Lowry’s work on 90-90 days (Charles Dow Award section, titled “Identifying Bear Market Bottoms & New Bull Markets”).
But was that really capitulation?
We can look at the family of McClellan Oscillator indicators to see if breadth was washed out enough for the market to form an intermediate bottom:
As the recent market history shows, when the Nasdaq McClellan Oscillator (Ratio Adjusted) falls below -60 it sets up a very good condition for intermediate lows. However, it is important to note that this is the case during ‘normal’ markets. In severe bear markets, like in 2008, this indicator will be pushed to an even more extreme low. So the key is whether we are still in a cyclical bull market or not.
Turning to the other major market, the NYSE McClellan Oscillator fell to -358.6 - this is a super-low level for the indicator, as you can see from this chart:
Source: The McClellan Market Report
But it is common to see it stay very low for a little bit longer and create a positive divergence with the Dow Jones, setting up for an intermediate low. That’s why McClellan is looking for stock prices to find their footing later this week.
Another way to look at this is to ask what it would take to get the McClellan Oscillator to zero. Here is a chart showing the advance-decline difference that would be required the next day in order to move the McClellan Oscillator back to zero:
Source: The McClellan Market Report
Tom McClellan, the son of the creators of the indicator, writes:
This number can also be useful in another way. When it gets to an extreme positive or negative value, it shows an extended condition for the market. This is the condition we see at the moment, in the wake of the stock market’s big decline this week on Greek debt worries and the “trading glitch” that sent the DJIA down briefly below 10000.
It is also worth noting that the extreme high values do not coincide with the final price low. They tend to arrive a few days ahead of the final price low, and so seeing a new extreme high value is a sign that the market is close to an important bottom, but not quite there yet.
So according to the McClellan Oscillator, the market will make a significant low later this week.
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