Sunday, March 25, 2007

Market Sentiment

Just when you thought it was safe to go long.

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First off, I haven't really explained how I'm using the bullish percent charts to gauge market sentiment. But as it turns out, I don't have to, as Babak does a nice job explaining how the BP charts can be used effectively. It's also similar to how I'm using it.

The path of least resistance for the markets remains down because:
- RSI put in a lower low
- MACD is trending down
- Moving averages are trending down.

In a true market bottom, the opposite of what I described would happen:

- RSI puts in a higher low
- MACD turns positive
- Moving averages have stopped trending down.

Granted, I don't think that the market will go down in a straight line from here. We may see some more market creep upwards before we come back down. But I say that the path of least resistance remains to the downside because I want to remind myself to remain open to this potential downside scenario unfolding, and to prevent myself from getting too aggressive on the long side. Sure, we've had a rally week (thanks to the FOMC), but we're certainly not out of the woods yet. The market needs to overcome a few technical hurdles before it's safe to go (aggressively) long.
In my mind, this also explains why breakout trading hasn't worked as well as in the past. Bearish sentiment is now greater than a couple months back, which creates confusion, a lack of direction, and increased volatility. Certainly the lack of direction works against breakout trading.

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