Thursday, October 29, 2015

Bear Rally Peak?

Ordinarily, I prefer to look at the 5-day forecast as a guide as to what is to follow. Candlestick patterns perform best as a near term strategy, and ChartDNA has performed well in its 5-day forecasts.

What was the shock was the risk:reward using a trade entered on today's open (whatever price that may be as the S&P hasn't opened) and held until either a 15% gain is achieved, or a 5% loss returned. There is an important caveat to this. The % win is not for the $SPY, because this would only return a handful of matches, but for component stocks in the $SPY.  While it would be very difficult for the $SPY to return a 15% gain over the course of a year, for individual stocks this isn't such a challenge.

What the data is stating, is that of the 250 matches from 481 component $SPY stocks exhibiting pattern #EHEB, only 4% returned a 15% gain after this pattern completed.  And the remaining 96% not only went on to hit the 5% stop, but actually collapsed to register an average loss of 7.5%; that is an awful lot of gap downs (past the stop).

The story gets no better as pattern length increases.  Pattern #BEHEB had 347 historic matches, of which 7% returned a 15% gain. Again, no real improvement for bulls.

All of this comes on the back of strong gains for the indices yesterday on the back of Fed comments on a December rate hike, which was perceived as strength in the underlying economy (and therefore bullish for markets).

Despite this bearish outlook, it doesn't equate to a favourable short play. The below outlook is the ChartDNA projection using the same format as above, but where a short is entered at today's open rather than a long.  In this scenario, using the same 15% reward to 5% risk, the % win rate is just 34% with an average return of 2.2% per trade. Different stop/targets change this a little, but not as much as the long side data would suggest is a slam-dunk short.

What the ChartDNA forecast does potentially show is an inflection point in the market. It the $SPY was to continue to gain (as powered by component stocks), then it will have taken the more challenging path. This would offer a case against a new bear market, which is still a possibility as long as the market remains below summer highs. If markets head lower, then the chance for a higher high diminish, and the case for a bear market remains as triggered by August's sell off.

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