Remember the people who told you in early 2008 that the market sell-off was “irrational” and driven only by “fear?.”
“Don’t sell,” they said, “you are in for the long term so look for bargains.” These same people are back. They couldn’t read a chart then and they cannot read a chart now.
How much worse can this get? Much worse. Particularly as U.S. analysts, fund managers and politicians, including the President are in denial. “America will always be a triple A country” is a refusal to face debt facts. Blaming, and investigating Standard and Poor’s is like attacking the teacher because you got bad marks in a school report – even worse when you say the same agency has accurate ratings on European debt.
Downside targets on the Dow are 10600 with a long-term potential at 9700. Downside targets on the Nasdaq are 2370 (already exceeded) with longer-term targets near 2100. Downside targets on the S&P 500 are 1130 (already exceeded) with longer-term targets between 950 and 1000.
Strategies for survival include:
Cut profits quickly and exit if it is not already too late.
Take small losses now – if its not already too late.
Trade short physical equities.
Trade short equity and indexes using CFD leverage.
Use CFDs to trade international markets where your own market offers limited short opportunities.
Trade gold for short term upside moves. Remember gold is priced in U.S. dollars and U.S. dollar will weaken.
Do not buy bargains. Wait for consolidation and end of downtrend patterns to develop.
Trading ultra short term – 10 minutes to several hours. This is the same as 2008, but worse because markets are coming off an already weak position.
Back in June we noted the developing head and shoulder reversal pattern in the Dow. As with all our technical analysis we discussed the conditions that validated and invalidated the pattern. Because the head and shoulder pattern is an end of trend pattern we spent more time discussing the downside targets and how they were calculated.
Technical analysis is not a popularity contest. The analysis method strips out the emotions, the funny accounting figures and outright accounting frauds and looks at the behavior and thinking of participants as identified through their buying and selling activity. Technical analysis looks at the opinions of those who count – the opinions that are backed by cash in the market or withdrawn from the market.
Its not a perfect analysis method and nor is it mechanical. If it were then technical analysis would be slotted into a computer program. The analysis of the relationships and behaviors shown on the price chart calls for some skill and experience. And even then it is not proof against error because despite our best intentions there are times when emotions and disbelief cloud our judgement. Our 2008 head and shoulder downside targets seemed unbelievable in late 2007. In fact they were conservative targets.
However good technical analysis provides the conditions that validate and invalidates the conclusions. The aim is to identify trigger points that signal a need for action, or a need to reverse a previous position.
The head and shoulders pattern on the Dow is a double pattern. It includes a larger pattern and a smaller pattern. In June the smaller pattern was close to confirmation and based on this the downside targets were 11700. By the end of July the larger head and shoulder pattern had been confirmed and this set new downside targets near 11600.
Whilst its always satisfying to have analysis validated by the market, it is even more satisfying to have used this analysis to lock in profits, avoid losses and be prepared to go short when the first signals are delivered.
And that underlines the next important step in taking technical analysis and turning it into trading profits. The head and shoulder pattern is a reversal pattern and it allows for the calculation of a measured move. It helps to set downside targets. This tells us the best side of the market is the short side until the index moves towards these target levels. Then traders wait to see how the support level acts as a rebound point. It is the nature of this rebound that provides the next set of long side opportunities.
We call it catching the bounce and its covered on more detail in one of our DVDs. This analysis tells us if it is better to trade the bounce as a rally, or when to trade it as the start of a new sustainable uptrend.
Technical analysis is not about being right or wrong in predicting how the market will behave. It’s about identifying the balance of probability and then identifying those conditions that tell us when the balance of probability has shifted. Those who are looking for prediction need to look to methods other than technical and chart analysis.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.
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