Despite the pain and grief everywhere you look these days at Hedgehog we are just continuing to plod on in our low key way, grinding out a profit most days.  We did nothing today as it was just too volatile.  But we have a decent month underway.  We are making new equity highs on the year so there is nothing to worry about here.  (Hopefully that wont jinx the month!)

If you missed the news this evening, no doubt you’ll catch the newspapers over the weekend.  “Biggest fall in the FTSE for 21 years”, blah blah blah.  The S&P did go as low as 839 today – almost exactly a 50% fall from its high last summer.

So here we are going out on a limb expecting shares to rally next week!  Well thats just what our model says so whatever we feel emotionally, we have to give it the benefit of the doubt.  Yes the market was down hard today, but we were getting buy signals on the shorter term timeframes towards the end of the day.

These signals (which obviously are not 100% accurate but are about as good as it gets) have to be placed into context.  In this case the buy signals would be no more than signals to exit any short positions, but certainly not to initiate new long positions.  The reason is simple:  the larger timeframes (daily, weekly, monthly) are all making new momentum lows.  Therefore the odds overwhelmingly favour new lows to come.  Those new lows may be many days, weeks or even months in the future but they will almost certainly be seen.

So short term we expect to see a bounce, probably over the next few days, but ultimately the downtrend will reassert itself – hence the logical interpretation of exiting shorts but not initiating longs.  Rightly or wrongly on this occasion that is what the model says and in the long term we take money out of the market by playing the high probabilities.

One important thing to remember is that bear market rallies can be very dramatic, but that does not negate the downtrend nor the downside momentum.  In other words this volatility is not going to disappear anytime soon!

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Copyright © Simon Townshend 2009, all rights reserved.

Follow Up: After this email was sent out to members the next 2 days delivered an astonishing 16.1% rally in the S&P 500.  A month later however new lows were being made again, exactly as the model suggested.

During turbulent times it is natural to worry.  Members who have been with us for a while have received these reassurances before, but for the benefit of our newer members this is just to put your mind at ease that today’s events have not caused us any grief at all.  We made a little money today, nothing too dramatic but the main thing is we are up and not down!

A few weeks ago we pointed out the v-reversal that created a short-term bottom and a 14% rally.  These are huge swings we are seeing these days!  Last week we finally closed below that low which set the stage for today’s sell off.  Early this morning we were discussing the possibility of a “Black Monday” after some pretty interesting activity on Friday.  The much talked about $700b bailout was finally approved and the stock market held it together for a whole 20 minutes before tanking to close on its lows!  A market that fails to rally on good news is internally weak.  A market that falls hard on good news is in serious trouble!  Hence today’s action.

For those that are interested here are a couple of statistics.  Firstly last weeks sell off was over 9% and this is an interesting observation:  The last two weeks that saw moves of this magnitude were in April 2000 (-10.4%) and September 2001 (-11.6%).  In both cases the market was substantially lower a year later.  As we know from our model momentum is a leading indicator.  These stat’s demonstrate that even on the longest of timeframes this type of momentum takes a lot of time to wear off, despite large and prolonged bounces against the trend.

The second interesting statistic comes from sentiment readings.  In our last message we pointed out that there was a higher chance of making an intermediate term bottom if everyone was bearish.  When the data was released it transpired that 49% of people were still bullish!  That was an amazing insight.  Markets rarely bottom without everybody being on the same side of the market, so until all of those people get panicked out of their long positions we are unlikely to turn back up.  So will we see an extreme sentiment reading this month?  We’ll have to wait and see.

Disclaimer, risk warning and copyright notice apply to all articles published on this site.

Copyright © Simon Townshend 2009, all rights reserved.