Trader’s Narrative

Last week we looked at the head and shoulder chart formation which was evident on almost all major stock market equity indexes.

It looked perfect. The symmetry of the rallies making the shoulders and head, the volume, everything about it was picture perfect. Perhaps too perfect. I warned about failed head and shoulder patterns which cause prices to bolt the other way.

Right now, it looks like it was a false pattern. It trapped many giddy bears in the 8200 level and then put them through the meat grinder, taking the Dow Jones Industrial up 6% in 3 days flat. As the shorts cried uncle and closed out their positions (either because they hit their predetermined stop losses or because of margin calls), the rally started by the bulls gained even more momentum. While many will explain it by saying it was because of Intel’s (INTC) earnings release, tape readers know the real reason.

Not only are we back above the neckline of the head and shoulders pattern, we are once again above the long term moving average (simple 200 day). When something is obvious to everyone, then you shouldn’t treat it as an edge.

Here’s a short video from MarketClub from Adam Hewison on the recent action in the the Dow Jones Industrial index and what he expects going forward:

The quick bounce wasn’t out of left field since we looked at very short term indicators which told us that the market had quickly gotten very oversold.

An interesting factoid: after today’s strong close, 75.6% of the Standard & Poor’s 500 component stocks are trading above their 200 day moving average. That is the best breadth from this measure since June 2007. It is significant that it has been recovering relentlessly after falling to less than 5% for six months (almost continuously).

Also, Monday’s and today’s strength was actually almost back to back 90%/90% days. Today 93% of the volume on the Nasdaq and 96% of the volume on the NYSE was advancing. Then again, we’ve seen so many of these extremely positive breadth days throughout the bear market that they’ve practically lost all of their ability to command attention.

While this may have the feel of a classic bear trap, I’m not sure we’re going to just ramp up from here. Instead of either a cascade down or a rocket ride higher, we might just be climbing back into the previously established range bound trading. In other words, the lazy meandering action that is endemic of summer trading.