Under the Dome 2

October turned out to be a brutal month for stocks causing a lot of technical damage as you can see when you look under the hood of the indexes at individual stocks. So many have begun to rollover after forming longer term topping patterns, a precursor and setup for potential bigger declines. A good example can be seen in the chart of Charles Schwab, SCHW.

As you can see over the last year, the price of SCWH has transitioned from being in an uptrend (higher highs and higher lows) to now being in a downtrend (lower highs and lower lows). Notice how the $49 area has acted as support during the entire transition. October’s selloff finally pushed the stock below support which opened the door for a quick flush and an almost 19% decline in 10 short trading sessions.

What Was Support is Now Resistance

As with most selloffs, this one too ran out of steam on capitulatory volume and on an oversold RSI momentum as the dip buyers and opportunistic traders stepped in to reverse prices higher. Higher they went to take back the majority of October’s decline. Notice where the recent rally stalled? Right where is should … the $49 area.  When support ($49) is broken from the top it becomes resistance ($49) from the bottom.

This is a great opportunity for short sellers to take a position, just under resistance. If SCHW rolls over to retest October’s lows, or even extend beyond there is at least a 15% return opportunity. To manage risk, if you are short there is no reason to hold the position if price moves back above resistance which would subject you to a small 3-4% loss. This works out to be a more than 3:1 reward to risk ratio, right in the sweet spot for risk capital opportunities.

Market Technicians – A Dedicated Lot

Tariff Direct Hit - Auto Stocks

In spite of strong US auto sales this year (annualized yearly sales > 17M), the President’s imposed automobile tariffs has had a direct impact to their stock prices. So far, only Tesla is positive for the year.

On Average – For What it’s Worth

When it comes to the markets, I detest the words “on average”. There is nothing average about a random system. But yet, as humans, we prefer structure and struggle with the chaos that non-linearity brings which is why we futilely attempt to organize it through averages.

In attempt to put the recent market correction into context, the author of the chart below has selected a small sample of data to determine the length of time it takes until investors find out whether a pullback becomes an opportunity (buy) or (sell) bear market. If the market weren’t random, this sort of data would be very helpful and of great value to every investor. Who wouldn’t want to know that all you have to do is wait 13 weeks, see which way the market is going and go all in (either short or long). Sadly, it’s never as easy as that otherwise we would all be gazillionaires. 

I give the author an “A” for effort but there is nothing actionable here nor does it provide an “edge” to make money. While the chart contains 47-years’ worth of data, depending upon their definition of a “bear market”, it may only consist of 4-6 data points which is too few to draw any sort of statistical inference and significance from. The bottom line is that because of the non-linear and random nature of the markets there is nothing average about “average”.

Target Met

Back on September 5th I wrote about a potential intermediate term top in the DJ internet index here. As we know by now, topping patterns in strong uptrends are likely not to complete since you are going against the longer-term trend which is why this example was only a “potential”. But, all trends eventually end so they should not be ignored. In this case, the downside target down at “T1” was significant enough to grab my attention. Not evident from my chart, the internet index was forming a topping pattern warning of a move lower while the broader market continued to move higher, pointing to clear divergence.

Fast forward almost two months and here is what has transpired since the post. The price of the index eventually broke below the (red) support line and chopped sideways for a couple of weeks. From there it attempted a quick rally, back-tested the underside of (red) support and immediately failed.

As you can see, the index has fallen and currently sits right on the T1 target. This is an area that should act as support and as such would expect price to consolidate or possibly reverse higher. If you shorted the index on the setup, congratulations, I would be banking profits. Going forward if the index can hold support it will present a nice, reversion to the mean investment trade. If not, this index and likely the overall market is in deep trouble and set up for a larger move to the downside. In my humble opinion investors should be treading lightly here waiting for confirmation this is something other than a “potential” bottom before committing investment capital.