What a real bounce looks like

Question from Flint:

If this is an example of a dead cat bounce then what would we look for in a real bounce… .

The best example I can find is the mini-crash of October 1997. The Dow gapped down sharply following a fall in Asian markets, but met with strong buying support the next day. The total correction of 12% did not reach the 6400 level from start of the year. The long-term rising trendline was not tested and 63-Day Twiggs Momentum declined but failed to break below zero. Volume doubled in the week following the crash, confirming buying support.

Dow Jones Industrial Average 1997 Mini-Crash

The 2011 crash is not specific to one region as with the 1997 Asian crisis. The index had not made much progress for the year and the fall of 17% broke well below the starting level of 11500. The long-term rising trendline was breached and 63-Day Twiggs Momentum dropped sharply below zero. Volume doubled in the week following the crash, as in 1997, but this is a completely different scenario: it would take similar volume for 4/5 successive weeks to stop the bear market in its tracks.

Dow Jones Industrial Average 2011 Crash

Early “Denial” stage in Europe

The FTSE 100 closed above 5300, indicating a rally to test resistance at 5600. This behavior is again typical of the early “denial” stage of a bear market. Resistance is likely to hold, leading to another test of 5000. In the longer term, failure of support at 5000 would offer a target of 4400*.

FTSE 100 index

* Target calculation: 5000 – ( 5600 – 5000 ) = 4400

The DAX rallied strongly, headed for a test of 6500 on the weekly chart. The bear market is not over, even if resistance is penetrated.

German DAX Index

* Target calculation: 6500 – ( 7500 – 6500 ) = 5500

A CAC-40 recovery above 3250 would signal a rally to test 3700. Expect resistance to hold, followed by another test of 3000*.

France CAC-40 Index

* Target calculation: 3000 – ( 3700 – 3000 ) = 2300

TSX evening star

The TSX Composite retraced to test the new resistance level at 12750. Declining volume and Friday’s red candle warn that buyers are losing interest. Reversal below 12400 would complete an evening star candlestick reversal.

TSX Composite Index

* Target calculation: 11600 – ( 12800 – 11600 ) = 10400

Dead cat bounce

We have a clear bear market signal across a wide range of indexes and current behavior is typical of the early “Denial” stage. If we look at 2008, the Dow broke primary support at 12800 in January, falling sharply before encountering strong buying support at 12000, signaled by weekly volume over 1.5 billion [1]. The rally failed, but buyers again snapped up bargains, with weekly volumes [2] above 1.5 billion. A third rally even penetrated resistance, but buyers soon lost interest and the next down-swing [3] led to a strong bear market over the next year.

Current buying support, with weekly volume close to 2 billion [4] is typical of the first stage of a bear market . Expect a rally to test 12000 followed by another test of  support between 10600 and 10800.

Dow Jones Industrial Average

* Target calculation: 10800 – (11800 – 10800 ) = 9800

Friday’s doji candlestick on the S&P 500 Index indicates hesitancy, and 21-Day Twiggs Money Flow below zero warns of selling pressure. Breakout above 1200 would indicate a similar rally to test 1260, but reversal below 1100 would signal another down-swing.

S&P500 Index

* Target calculation: 1125 – ( 1250 – 1125 ) = 1000

The Nasdaq 100 Index displays stronger buying support, as evidenced by the long tail and small bullish divergence on the weekly chart. Expect penetration of resistance at 2200, but the primary trend remains downward and reversal below 2200 would confirm.

Nasdaq 100 Index

* Target calculation: 2200 – ( 2400 – 2200 ) = 2000

For those who follow classic Dow Theory, the Transport Index broke below 5000, confirming the bear market. 63-Day Momentum further strengthened the signal with a strong fall below zero.

Dow Jones Transport Average

* Target calculation: 5000 – ( 5600 – 5000 ) = 4400

Jermy Grantham: Danger – Children at Play

The main long-term risk is that after two massive bubbles and two equally massive resurrection programs, the Fed may be out of ammunition. Should more building blocks fall (government bond downgrade and further market declines have missed my deadline) and a serious global double-dip develop,  then the pattern of market behavior this time may be more historically typical. That is, instead of quickly recovering, markets will become cheap and stay below long-term averages for several years as was the case pre-Greenspan.

Jeremy Grantham: Danger – Children at Play (Scribd).

US & Canada target levels

The Dow Jones Industrial Average broke primary support at 11800 but encountered buying Friday around the former primary level of 11500. We may witness retracement to test resistance at 11800, but this is expected to be overwhelmed by sellers. Medium-term target for the down-swing is 10800*.

Dow Jones Industrial Average

* Target calculation: 11800 – ( 12800 – 11800 ) = 10800

The Nasdaq 100 fared better, recovering above primary support at 2180. But Twiggs Money Flow below zero, and the earlier bearish divergence, warn of strong selling pressure. Failure of support is likely and would offer a target of 1920*.

Nasdaq 100 Index

* Target calculation: 2180 – ( 2440 – 2180 ) = 1920

The TSX Composite Index was one of the first markets to enter a primary down-trend and has now confirmed with a break below the latest support level at 12750. Expect some support at the target of 12000* but the July 2010 low of 11000 beckons.

TSX Composite Index

* Target calculation: 12750 – ( 13500 – 12750 ) = 12000

UK & Europe

The FTSE 100 continued on its downward path, approaching its calculated target at 5100*. Expect some retracement this week, but I would not place much reliance on support at 5100 — strongly suspecting that we will see a test of the June 2010 low at 4800.

FTSE 100 Index

* Target calculation: 5600 – ( 6600 – 5600 ) = 5100

The German DAX index has already passed its initial target of 6500 and is headed for a test of 5600.

German DAX Index

* Target calculation: 6500 – ( 7600 – 6500 ) = 5400

US stampede

A friend at golf yesterday, who still holds a number of stocks, asked if they are likely to fall any further. My answer was that holding on to stocks in this market is like standing in front of a stampeding herd in the hope that it will stop before it reaches you. There may be a short retracement early in the week, but strong selling is expected to overwhelm buying support. On August 3rd I gave the probability of a down-turn as 75 percent. The odds are now about as close to 100 percent as you can get.

S&P 500 Index

The S&P 500 followed through below support at 1250, confirming the primary down-trend. Friday’s brief rally was swamped by further sell orders. The herd has started to move. We are beyond the tipping point.

UK & Europe crash

Posted August 3, 2011 8:00 p.m. ET (10:00 a.m. AET) on Trading Diary.

The FTSE 100 followed through below 5600 after breaking primary support at 5650, confirming a primary down-trend.

FTSE 100

 

The DAX similarly broke primary support at 7000 on the weekly chart and is now testing its earlier support level at 6500 — breach of that would be the final nail in the coffin. Bearish divergence on 13-week Twiggs Money Flow has been warning of selling pressure for several months.

German DAX

Dow at the tipping point

Posted August 3, 2011 8:00 p.m. ET (10:00 a.m. AET) on Trading Diary.

The long tail on today’s candle for the Dow Jones Industrial Average indicates buying support, but 21-Day Money Flow below zero warns of longer term selling pressure. Only recovery above the rising trendline would call the bear signal into question. Follow-through below today’s low at 11700 would confirm the primary down-trend — as would a close below 1250 on the S&P 500.

Dow Jones Industrial Average