Is This The Real Deal?

Or is it another Bull Trap / False Break-Out / Dead Cat Bounce / Rally-in-a-downtrend / Bear Rally …

With the benchmarks breaking out of their respective downside flags, this could be another serious spike for new highs. The only problem will be the volumes that get weaker with each up tick. Also, DOW seldom makes a bullish 1,000 range in five days and whenever it did, it gave it all back in a hurry.

In the last five years, DOW has made only three bullish 1,000 ranges in a week including the current one. The other two times were in October and November 2008 and the resultant trends were obvious …

Another uncanny similarity from the 2008 1,000 point weeks is the dip in volumes every time the market made gains. This is called Price-to-Volumes Divergence. This translates to a rally that is unsustainable or as some would call it, a False Break-out. This phenomenon almost always ends up breaking down to newer lows as was the case in October and November 2008.

Now take a close look at the last five sessions leading up to the Monday 10 October 2011 close in the chart below … from the low of 10,404 on Tuesday 4 October to Monday 10 October’s close at 11,433, the DOW has gained made more than 1,000 points in five sessions on consistently lower volumes. You will also notice that volumes today are half of what they were in 2008 which makes this market more susceptible t0 major gyrations. Thus it won’t take much to tank this market when volumes are so weak.

If you didn’t know Price-to-Volumes Divergence, now you do. You’ve seen the results of this from October and November 2008 and that is why I will not be convinced to reduce my hedge, let alone turn Bull as long as volumes stay unconvincing and sector leadership stays inconsistent. The VIX is still at heightened fear levels (above 30 points) and it didn’t help matters that the bond market was closed Monday. With no bond trades to counter-check the “buying” in the risk market, investors stayed sidelined as evidenced by the drop in volumes.

A few readers have asked what would be the likely catalyst for the tanker if we do get another crash.

There is no way to know what it will be but here is a timely reminder;

In the Crash of 1929, the morning of Monday, October 28, 1929 started out like a normal day. The market had already been showing signs of a top since September 4, 1929 but the general public continued to live like the problem wasn’t serious. But the structural weaknesses within the economy were very obvious and the financial system was over-stretched with leveraged debt.

Wall Street, 29 Oct 1929.

Then in the middle of the trading session, with no reason, no catalyst and no warning whatsoever, the market started tanking after lunch. By the close of Monday, October 28, 1929, the market had lost 13.5% in a single afternoon. The following day, October 29, 1929, the market crashed in what became known as Black Tuesday. The market and economy had started a -91% downtrend and it never looked like recovering till WWII provided the greatest bail out of all time.

Many of such major crashes happen this way. The market doesn’t need a catalyst to crash when the reasons have already been there for a long time but the public ignorantly denies the gravity of the problem and governments behave like they have a fix for any such circumstance. All it takes is a sell off to get out of control as in 15 to 19 October 1987, 23 to 27 October 1997, 27 August 1998, 6 to 17 Sep 2001 and most recently on 2 October 2008.

Will history repeat itself? Or will this October turn out to be a Bear Killer as it has happened 11 times before in the last 70 years in 1946, 1957, 1960, 1962, 1966, 1974, 1987, 1990, 1998, 2001 and 2002 when those Octobers turn a bear market around?

I remained hedged and under-committed till the market tells me otherwise. I am not that brave to risk good money on a fickle market now.

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