Let me preface this post by saying I much prefer to use fundamentals than technicals for basing my decisions, and I think I'm a lot stronger on the fundamental analysis side of the ledger. I employ KISS thinking for TA - and certainly many others can swin circles around me on calling the next 15 minutes or next 3 days employing 31,000 indicators - of which 30,997 I have never heard of. That said, ignoring technicals or not understanding them is something I think many managers and individual investors are making a large mistake in doing. To many they just say its reading tea leaves ... once every 3-4 months I use this example to explain to them why it is not.

If someone told you when it was 90 degrees or more in Miami, sweater sales exploded higher - you'd laugh. You'd say it made no sense. It's tea leaves!. But if this was the pattern, and many people followed it, and you were a sweater merchandiser you'd be stocking up ahead of >90 degree days. And the more times it worked, the more people who would follow it. That's basically how I look at technical analysis - a lot of these things make little sense from the perspective of - why is the 20 day or 200 day or 50 day moving average important? Why is not the 47 day moving average important? Who is this Fibonacci guy? Why does a 33%, 50%, 67% retracement mean anything?

But with a lot of whales now using these levels, and we can see so many patterns respected at resistance or support you just have to be aware of it, even if you choose to ignore it. The other thing I've been saying the past year, is we are in an abnormal time where the market direction is 90% of the trade... meaning individual stock picking has not meant much. This works against my strategy and in fact any of us who rely heavily on fundamentals. If you catch the direction of the market move, you will be a genius nowadays no matter what you buy. And vice versa. I personally hate it, because I have to waste much of my time sitting here looking at charts of NASDAQ, S&P 500, Russell 2000 and trying to read tea leaves on where the magic squiggly lines will take us. That has nothing to do with if ABC company is accelerating earnings, or developing a new technology. So the current stock gods now are those who can figure out the direction of the market on a daily, weekly basis - because picking individual stocks is a moot point and has been for the past year; get the market trend right and 80% of your work is done. When I've been successful the past year, its because I've been on the right side of the trend - and vice versa. This is different than before summer 2008 when some sectors went up even as the market went down... or the opposite. Again, I personally hate this sort of environment but this is what we've been stuck in... it is the student body left, ETF dominated, sector rotation world we live in. How long it lasts is an open question ...

Now what strikes me as curious is if these 2-3 month waves up and down are just going to continue endlessly - 2+ months down, followed by 2+ months up, followed by 2+ months down, followed by 2+ months up. It seems too simplistic. Crash, rally, crash, rally, crash, rally?? That's the market now?

So stepping back a bit, as we came off the lows in early March I thought we had a good chance to hit S&P 870-875.... I thought it would take a pretty extended time. We got there, and fast. And then we passed it, hitting S&P 930 intraday twice last week. I said about a week and a half ago around S&P 900 that I'd expect this market (at that point) to go farther than many imagined up, and then I would find it hard to believe we fall a cute 5-7% so everyone can buy in who missed the move. The market likes to inflict pain to as many people as possible. So indeed we moved to S&P 930 (farther than many imagined) and now has pulled back lo and behold we are down 5% from the high.

I have been buying this dip going against my own advice. Stoopid (sic)? Probably - because I said it would not be so clean and convenient that those who missed the last part of this move would just be let in. My gut says those who buy this dip will get squashed because it would just be too easy. But I don't know that - that's just my gut.

We are at an important inflection point and there is still a potential for another leg up technically. Or a break down. With technical analysis, it is an art - not a science... I look at the mosaic of information and then assign probabilities. Sometimes the 5% probability wins, sometimes the 95% wins. As a dip buyer (i.e. potential sucker) I have two points of support that we are now at.... the 20 day moving average (S&P 880) and then S&P 875, which was the level we previously cited over 2 months ago as an ultimate target. There is a saying resistance becomes support (and vice versa).... S&P 875 is extremely key to hold for bulls.

Let's look at the chart - this entire rally has been supported by dips to the 20 day moving average. Other than March 30th and April 21st we LITERALLY stopped dead on the tracks on intraday moves downward at that moving average, and even those days we dipped maybe 2-3 S&P points below. Why is this level important? I have no idea - see the sweaters selling in Miami ... thousands of eyes, electronic and human see this trend, and buy at that level ... it will work until it doesn't. But again, it shows you this tea leaf reading is not arbitrary - so many people do it that it self reinforces. Where did we bounce off yesterday and this morning? You guessed it - just above S&P 880.

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So we have S&P 880 as the current 20 day moving average and it creeps up every day. That doesn't mean we cannot go to 877 and the story is over... you have to give allowance +/- a bit. But as I stated above below this 20 day moving average we have the resistance is support area of S&P 875... this level was the intraday highs of late January and early February 2009. Hence this is where I thought we'd stall out eventually in the rally. Instead we sliced through them like hot butter... but again, this is all probability theory. Does that mean S&P 875 will provide support on the way down? Not necessarily but the probability is high. At the minimum it should provide a place for a bounce, if indeed we break below the 20 day moving average.

But from there, it will be extremely dicey... because just as momentum can flip one way, it can switch on a dime. Since the economic and fundamental background is so murky and there are debates to be had either way, it just seems many people have leaned on technicals. And if S&P 875 breaks, it could lead to much further downside. If this happens, I'll flip my switch - put on my parachute; take moderate losses and then get heavy on the short side for the intermediate time frame.

What are some potential levels if that does happen? My belief is it will be hard to get back to S&P 666 again - we literally were talking of nationalizing the entire US banking system... but all lows are tested eventually. An extremely bullish condition would be to break down later in the year (whether that be in 2 weeks, 2 months, or 2 quarters) but not get all the way to S&P 666 - I am looking at S&P 740 myself (highlighted in aqua above). If we bounced there that would give us a higher low and the seeds would be there for a true bottom to be put in place. That's my roadmap on how things might happen later in the year but knowing when is impossible. Of course another probability is we get all the way back to S&P 666 and then bounce from there - that would also be construed as bullish (double bottom)... and the bearish outcome is we get back to 666 and then break it, which means we start the whole cycle again - an oversold bounce, consolidating and then a retest of the new lower level (wherever it may be) in 2010.

I'm not a fibonacci guy myself, but again I have to respect the fact so many people use it - there are basically 3 levels (from my understanding) of pullbacks. You take the length of the move (in this case S&P 666 to S&P 930, assuming we go no higher) = 264 points. Then you say we give back 33%, 50%, or 67% of that move. Which would work out like this

  1. 33% = S&P 843
  2. 50% = S&P 798
  3. 67% = S&P 753

The latter one is interesting to me, because it sort of fits in with my finger in the air call for a potential pullback to S&P 740. But what I love about fibonacci guys is they always give themselves 3 outs... if its a minor pullback they can say clearly a 33% pullback, and if its moderate they can say clearly a 50% pullback and if its a major pullback called it! 67% pullback ;)

EDIT 1PM: Looks like the Fib retracement levels are 38.2%, 50%, 61.8% so #1 above is instead is S&P 830 and #3 is 767 (you can see how often I use this... ahem, thanks for the correction Bill)

So that's all downside... to the upside the very obvious 200 day moving average awaits us - around S&P 970 and falling by the day. If we get above that, it would make little sense to me from a valuation standpoint but the squiggly line folks would be gasping in excitement and HAL9000s across the country would be sent it to buy the market. But I will still say that just sets us up for an even greater fall because all lows are eventually tested... the higher we go, the longer we have to fall to do any sort of retest.

None of this has to do with the economy, or fundamentals, or company specific traits - but right now the squiggly lines seem to dominate trading so that's my view and roadmap from 40,000 feet. Don't mistake my buying for any bullish connotation... I'm still only 50% long and willing to switch on a dime. While I believe I own a lot of solid companies, the individual company metrics mean nothing if we return to a time of fear, famine and pestilence. We've found that out multiple times the past year and a half.

Long story short, this S&P 875-880 level and the behavior around it will be going a long way in shaping my portfolio one way or the other in the coming days / weeks. And of course if we look at the other indexes - especially NASDAQ - we see further advanced testing going on of longer term moving averages.