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Dorn: A Shock and Awe Bear Market Rally?

The psychology of the markets was pushed so far in the direction of fear on Friday that people just wanted out at any price. Fear and loathing was palpable and the news was uniformly hideous. The spillover from Wall Street was everywhere on Main Street. Even at the gym, people took time from heavy lifting to talk about how horrible everything was. Newspapers were full of doom and gloom, and I received an “urgent alert” from one of the oldest and best-known newsletter writers instructing people to go to the bank and draw out large sums of cash because their were rumors of a bank holiday and it was likely that G-7 would accomplish nothing over the weekend but make things worse.

Looking more closely at the 1000 point range in the Dow on Friday, it is about as clear as it can be that the markets did their work on the downside—at least for now. It’s payback and snapback time now! The easy money has been made on the downside. ES, YM and NQ traders that particpated in the downside action over the past week can take the rest of the year off. They have exceeded their yearly goals as these were opportunities for catching massive sell-offs that we have not seen since 1987 or 1929.

We now appear to be on the verge of a shock and awe bear market rally that will leave all of those who sold at or near the bottom on Friday shaking their heads in disgust and regret. The bear almost killed them and then—suddenly walked away.

What did we see on Friday that may portend for a sharp and likely brief rally that could take the Dow up as high as 10,000 plus before the downage to retest the lows?

1. The abysmal behavior of gold in the final hours of trading, indicating that there just might now be a need for so-called flight to quality. Gold dropped nearly 7.5% on Friday and is once again trading below its 200 period moving average.

2. The pompous prognosticators were out in full force, issuing targets for the Dow of anywhere between 3000-7000. So called gurus went on national television to tell everyone to get out stocks because we were going a lot lower. ( Things that make one go hmmmmmmm?)

3. For every sell there is a buy, and someone was buying. We must never forget the story of the old men of Wall and Broad that sat in their brownstones and waited for blood on the streets. When they saw it, they would pick up their canes, hobble down to the exchanges, buy and hobble back. Many canes came out on Friday.

4. Traffic on my website picked up significantly, and I had more requests for help in the past two weeks than in the past two months.

5. The CBOE VIX traded at 70-- its highest level in history. It broke out above the through the channel in which it had been rising since September. This portends a reversal down in the coming week, indicating that fear is coming out of the markets and some confidence may be returning.

(6). The OEX put/call open interest ratio reached levels historically seen at interim market bottoms.

We are in the time frame and the price frame now for October to show itself as the “bear killer.” Most market participants have now abandoned hope. The bear has mauled them to the point of being bloodied and battered. Now, the bear will hibernate for a while, allowing the injured to attempt to recover in the healing light of a rally. There is way too much technical damage to the indices at this time for this to be the start of a new bull market. V-shaped recovery out of this carnage is not to be trusted, Rebuilding from this degree of technical damage will take time, and it is likely to be a steady slog upward into January before the bear decides it’s hungry again. By that time, the victims of the bear attack will have recovered to the point where they think it’s safe to go back into the woods again. It will be too late. The bear will be waiting for them, more hungry than ever.

This is the ever-changing cycle of greed, fear, pride and regret that has been with us since the beginning of the markets. As devasating as this has felt to many, it is a fabulous opportunity to learn how to be totally in touch with your emotions. In the markets, you will always be greedy when you should be fearful and vice versa.

Is the buying opportunity of a lifetime upon us? I don’t think so. As always, it depends on time frame . As a futures only trader, I know that this is a traders paradise—both on the upside and the downside. The markets offer limitless opportunities to those who have learned to fade their emotions, think counterintuitively,leave their biases at the door, and always remember to plan their trade and trade their plan.

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Janice Dorn, M.D., Ph.D., is a financial psychiatrist and chief global risk strategist for Ingenieux Wealth Management in Sydney, Australia. She also offer trading consulting and coaching services via her Web site, TheTradingDoctor.com.

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