There are many ways a market can correct, how it moves down determines how it will rebound or rally and when it will reverse back to an uptrend. What you need to learn to watch for are:
1. The Speed at which price falls versus the bounces up
2. The level of volume on down days versus up days
3. The Market Participants selling short or selling in panic
4. The Angle of Descent
5. When Quiet Accumulation Patterns appear
Below is a chart of the NASDAQ Composite Index. This index has outperformed the Dow 30 and the S&P 500 since the rebound into rally of mid 2009.
Since it has outperformed and had better stock advances than the Dow or S&P it is logical to study this index in expectation that it will continue to outperform as this “old” news based selling fades and the rally commences.
Chart 1
Let’s study the 5 areas of the price and volume action for this recent correction.
1. The speed was extremely fast, faster than other retracements during the trading range. This means this was NOT distribution by large institutions but was a panic mode of smaller lot investors and retail traders.
2. The level of volume between down days and up days is on par or fairly even. That means the balance between those panicking and selling based on old news and those buying on dips or at bargain levels based on fundamental data are about equal. This is one reason the market has been so volatile in the past week. Neither side actually dominants. What is happening is large lot and wise institutional managers are allowing the panic of smaller investors to push price down, they wait then move in as a good bargain occurs or when their buy trigger price hits.
3. Distribution by large and giant institutions is very systematic and visual on the charts. Whenever the TTQA indicator turns green then red then green of approximately equal length and duration, this is not distribution or quiet accumulation but merely professional traders trading within the range up and down.
4. The Angle of Descent was extremely steep, a near perfect 90 degree drop. This angle is unsustainable for extended periods of time so just by watching the angle the value descends gives you a good idea how long this fall will last. This one bounced above the lows of 2010, considerably above that strong support level. Angle of descent or ascent is a critical aspect of good chart analysis. Anytime price is moving at or near an 90% angle, the run will be short-lived.
5. Volume accumulation and Flow of Funds are showing a bottoming pattern. The collapse was an accelerated sell down due to the lack of the uptick rule which makes a panic market downside action move even faster.
Conclusion: We are in a period of extreme price activity. Smaller lots are selling but larger lots are buying or holding. The “sandwich” candlestick pattern that formed on most of the indexes and many stocks last week is a common pattern since the uptick rule was eliminated.
Summary: It is not just stock buyers and sellers creating all the volatility and huge reversal patterns on the indexes last week. There are many other contributing factors:
1. An unusually high number of Option Puts on stocks were bought during the downtrend. It is common for institutions to hedge their held stocks they do not want to sell by buying puts. They can either sell the put later on or exercise and take possession of the sell short position, trade it down and then buy to cover. Since there was a staggeringly high volume of option put trading, this contributed to the wild volatility last week.
2. Downgrade swaps. These derivatives are fairly new. Basically it is insurance for institutions against a market meltdown IF a downgrade of the US rating was downgraded. Banks and other companies that create derivative swaps sold institutions these derivatives. Exercising these derivatives causes major shifts in stock values because the underlying security is either a bond or a stock.
3. Mutual Fund redemptions: Thus far only 14 billion has been removed from the big Mutual Funds. If more people demand redemptions then the market is likely to fall further. So far institutions have not had to sell off stocks they would prefer to hold through this correct.
4. TIPS another type of T-Bill derivative. Treasury Inflation-Protected Securities are designed to protect against inflation.
5. Small investors buying Gold. 48 billion dollars went into gold instruments. This pulled a huge chunk of small investor monies out of stocks suddenly. But those buying gold now are buying at a huge risk as Gold heads to a V top formation.
Trade wisely,
Martha Stokes, C.M.T.
Member of Market Technicians Association
Master Rated Technical Analyst: Decisions Unlimited, Inc.
Instructor and Developer of TechniTrader® Stock Market Courses
http://technitrader.com
MetaStock Partner
©2011 Decisions Unlimited, Inc.
Disclaimer: All statements, whether expressed verbally or in writing are the opinions of TechniTrader, its instructors and or employees, and are not to be construed as anything more than an opinion. Student/subscribers are responsible for making their own choices and decisions regarding all purchases or sales of stocks or issues. At no time is any stock or issue on any list written or sent to a student/subscriber by TechniTrader and its employees to be construed as a recommendation to buy or sell any stock or issue. TechniTrader is not a broker or an investment advisor it is strictly an educational service.
