April 23rd, 2008

Beware Suckers’ Rally

I last wrote about the state of the market on April 17 when the S&P 500 last crossed above its 60-day moving average and was lurching ahead to cross the 90-day moving average. In that post I wrote:

Some may say the market has clearly demonstrated upside momentum but my back tested indicator says substantial risk of a downward reversal is still present. The market will not have proven itself, and that risk will not have dissipated until the index crosses over the 180-day moving average.

Markets with similar alignments of index and moving averages, where the index cross the back above the 90-day moving average, are markets with a high risk of “recidivism”. In the 68 times this has happened since 1964, the index has reversed and fell back below the 90-day moving average 62% of the time. Let me state the obvious …. those are less than 50/50 odds of winning!

And sure enough, here we are a few days later, after the Index successfully went to the upper boundary of that channel and today started heading back south:

It’s getting quite congested in this range and something significant has to happen before momentum either up or down can materialize. The 60-day MA is creeping up to meet the descending 90-day MA and the Index failed for the 4th time to cross over the 1385-1390 level. And we’re about to experience another bout of recidivism as the Index was about to crossed back under the 90-day today.

I’m at a loss as to what to suggest other than to ask you to stay cool and keep your powder (your cash) dry. A clear sign to jump in with both feet (move to 100% invested or more if you’re a true trader and embrace margin) is 3.95% away …. where the Index crosses over the 180-day MA.

If the Index successfully breaks through the upper boundary of this channel at 1385 with some volume conviction, the move to the 180-day MA could be made in several 1.5%+ day moves. But first we’ll have to overcome the hesitation at 1408, the point where the Index bounced and thereby created a support trendline which now might act as another resistance level trendline.

But we’re counting our chickens before they hatch. I’m not predicting, I’m only speculating, playing a “what-if” game so that should it come to pass we have a game plan and we don’t get carried away by all the hype we’re sure to be bombarded with. When it comes to making money, emotions easily can grab us and we throw caution to the wind.

There have been too many cases when situations like this have backfired … and that’s why they’re called suckers’ rallies. I’m willing to give up a couple of percentage points as insurance to make sure that the rally is sustainable and not going to succumb to the overwhelming negative news that’s still out there.

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