Trading Strategy

Those who follow my blog should remember what I said a week ago in the "Advance/Decline" post on November 1, 2009: "Yes, if we take a look at major technical indicators (beside volume and advance/decline) we will see that almost all of them are bearish and suggest the higher odds of further decline. However, I would not be very sure in this and personally I do not hold any short position right now. Yes, we still may see some decline, however based on my experience working with volume and advance/decline data I would consider possibility of coming reversal and I would monitor index charts more closely for bullish signals that may confirm my analysis."

Now, you may see that indeed extremely low advance decline readings in the S&P 500 index indicate coming reversal and uptrend. If you take look at the hourly index charts (S&P 500, Nasdaq 100 and DJI) you will see that already on Monday November 2, 2008 by the end of the trading session MACD and Stochastics have became Bullish, shortly after the market open on November 3, 2009 Advance/Decline Ratio and RSI became Bullish and by the end of the trading session on the same day McClellan Oscillator and SBV Oscillator indicated Bullish sentiment.

Strong up move during the rest of the week has pushed S&P 500 and Nasdaq 100 indexes to their high levels on September 17-23, 2009 and DJI index to its high on October 16-22, 2009. At that time (in September and October) the indexes have been moving sideways for several trading days. Furthermore, I would say that we may see some sideway action at this level again. Actually, we already started to see slowdown in the recent rally up and some of the technical indicators started to show tendency to become bearish. If the market starts to move sideways the odds are high that the technical indicators will become bearish. However, personally, if this is a case and technical analysis starts to generate bearish trading signals I would not wait for a strong correction. There are several main reasons why:

 - The recent correction has generated high volume surges at its support level, yet we have not seen any increase in volume during the resent recovery. Furthermore, I may say that the recent recovery did not generated waves of greedy buying which could change a supply/demand balance.

 - The market becomes less volatile which could be clearly seen on the VIX index (volatility index) decline. As a rule a decline in volatility suggest that the market becomes more stable and higher odds of up-move.

 - During the recent decline we saw twice the S&P 500 hitting extremely low advance/decline readings (on October 28 and October 30, 2009). This suggests that the marker became strongly oversold at its support level. So far I do not see any indication of market becoming overbought.

Overall I would say, yes, if technical analysis starts to generate bearish signals we may see some sideway move and even a correction; however I would not consider the bearish trading signals as a reason to open a short trade in the current market stage. One of the conservative and safe trading strategy when the longer-term trend could be defined as bullish could be described in two simple rules:

Rule #1: Open a long trade when you see Bullish signals;

Rule #2: Stay in cash and wait for Bullish signals when you see Bearish signals.