The first sign that indicates the market might be heading toward the turning point was on September 15, 2014 when the DJIA closed with a gain while all the other market indices did not. This was something different that the market has not done for some time. Then on September 16, 2014, the DJIA flirted with the all time closing high throughout the trading session. But it failed to close with a new all time closing high as it backed off near the end of the session. And one wonders what it would look like if the DJIA did closed with a new closing high. Finally the next trading session, September 17, 2014, the DJIA closed with a new all time closing high and enter into the record book. But there were something missing, the SP500, the Nasdaq 100, and the Russell 2000 did not accompany the DJIA into the record book. Only the DJTA made a new all time closing high with the DJIA. This gave the DJIA a confirmed closing high based on the Dow Theory. This confirmation is significant as it indicates the DJIA will have at least one more new closing high before the turning point arrives. The market did not disappoint as the DJIA put in another new all time closing high in the next trading session, but this time it is slightly different. This time the SP500 and the DJTA joined the DJIA into the record book with the Nasdaq 100 putting in a new multi-year high. Once again, this new record high from the DJIA did not signal the market has topped and that implies at least another new high is expected from the DJIA. On September 19, 2014, the DJIA made its third consecutive new all time closing high and a huge celebration broke out. But, shhh…listen, that celebratory sound was not from the new DJIA record high celebration, instead it was from the Alibaba IPO celebration. And as many experienced market watchers know, there are no fanfares when the market has reached a turning point, as there is never an announcement from the media talking heads announcing that the market has topped out, and neither will you see a headline saying “The market has topped today!”
Since September 19, 2014, the market is adjusting to its new direction. During the initial phase of this adjustment, there will be many brief violent bounces. These bounces will fool many traders into believing these are buying opportunities. Unfortunately, many of them will be trapped and will not realize what has happened until some damage has been done to either their financial capital and/or their mental capital. For the experienced traders, most of them will take their losses and move to the right side of the trade. But unfortunately for those inexperience or emotional traders, they will hang on to the belief this market will come back soon and this decline is only temporary. They will listen to those talking heads speaking about how good things are and how the market will be back in record territory as soon as this minor correction is done. And lastly, they will find short lived comfort by listening and believing the talking heads saying this pull back is healthy for the market.
Indeed, the market will always come back, but not the way those talking heads speak. Before the market makes a turn to reverse its direction once again, it needs to convert those hopeful traders into despair traders. After these despair traders have capitulated by dumping their holdings at any cost that is when the market will start the process of reversing direction. But for now, it is much too early to talk about that phase of the market cycle. It will be at least months if not years from now before the first sign of this phase begin to take form. Until that has happen, there will be numerous bounces during the market decline that will generate false hope of a market turnaround. There will be bargain hunters and bottom fishers trying to outwit the market believing they can buy low and sell high during this decline.
As some of you have finished reading the above will be questioning how can the market has reached the turning point when the market price chart does not show a price pattern indicating a top has been formed. The reason for those of you that pose this question is you are using the wrong tools to monitor the market. When we perform technical analysis on an individual stock, we look for price patterns, support and resistance levels to determine where the price might be headed. But when we monitoring the market, price patterns and support and resistance levels are secondary. The primary tools for monitoring the market are market breadth and market structure because the market is comprised of a collection of stocks. And one needs the tools to monitor what this collection of stocks are doing and how are they performing collectively. Some of the market breadth indicators used are: advance-decline issues, new high-new low, up volume-down volume, and many more. It is the market breadth and the market structure that will provide us the clues to determine if the market has reached the turning point. And if one waits for the price pattern to confirm the turning point, many stocks will have already experienced significant price drop. Certainly some of you probably dismiss the premises on the need to monitor the market at all since the price action in the stock will alert you on the impending trend change. To some degree, that is correct. But the significance in knowing the state of the market is it will help a trader to determine what trading strategy to employ. If the market is in an uptrend, then buy the pullback (buy the dip) off support would be a good strategy to employ. But if one does not know the market has turned, similar strategy being employed in a downtrend will cause a trader to walk into a bull trap as these bounces will be misinterpreted as buying opportunities instead of treating them as selling (shorting) opportunities, and vice versa for the market that has bottomed.
From my observation on the events that took place between September 15 and September 19, 2014, the market has indicated it has reached the turning point. I could be completely misinterpreted what I saw. But until the market tells me otherwise, I will continue to hold the view that the market has reached the turning point for this market cycle and I will begin monitoring for a market bottom. As always, trade defensively and trade your plan. Remember, capital preservation is priority #1 and cash is a position.
Here are the charts for the indices with some near term levels to monitor.
DJIA:
(click on the chart to enlarge)
SPX:
NDX:
RUT:
