Dow is gunning for the top – now with oxygen

Sir Edmund Hillary, the Kiwi hero of the first successful climb to the top of Mount Everest in 1953, said afterwards: “It is not the mountain we conquer, but ourselves“.

And that sentiment very much encapsulates the challenge in becoming a great trader.  As it says in the bible; ‘ Many are called, but few are chosen’.

I believe trading the financial markets is one of the most difficult endeavours anyone can take on as a career. Yes, I am sure like me you know of someone who bought Apple or Amazon early on and is still holding for a massive gain.  They are not traders, they are lucky investors.  But you can be sure that the mentality that got them into this investment (that is, a big story) will almost certainly serve them ill if and when when the shares enter a severe bear trend.  They will almost certainly ride the up and down escalator!  Bulls fall head over heels with their book at tops.

No, traders like me attempt to get in at or near a low and exit at or near a high – and vice versa.  We do not fall in love with any market or investment idea.  That is the route taken by the vast majority of investors – and that is why screeds of coverage of individual companies and sectors are available – they have a huge audience of the like-minded.  You see it in the Financial Times, Investors Chronicle, and many other UK publications.

I have to say that most of it is pure hokum and hopum and reflects the bullish (or sometimes bearish) natural bias of the herd. What better way to attract readers (and advertisers) than to cover a share or sector that has been in a strong bull trend for a long time?  These articles merely reflect the bullish bias in the market that is possessed by the vast majority.  They project the established trend into the future and are of no use when trends change.

How much advertising money will flow to contrarian pieces in the MSM? But that is where savvy traders are always looking!

Yes, today’s stock market has a very fractured sentiment picture.  The public are suspicious of the booming rally because it does not generally accord with their experience of great economic times as suggested by stocks. Yet the pros are all in with sentiment measures at or near all-time record positive.  Today, the pros believe nothing bad can happen anytime soon.  There is a severe employment risk in tilting at this windmill.

The latest DSI (Daily Sentiment Index) of money managers shows a highly elevated 91% bullish reading – the highest in three years.  In a previous post, I showed other measures that confirm this extreme bullishness on the part of the money managers.

This is extreme herding pure and simple.  All of the bulls are massing on one side of the boat and the paltry number of bears on the other. Soon the water will start lapping over the gunwales and tip the whole thing over. The only safety will be on the bears side as they remain high and dry.

I have been preparing for such an event in stocks for some time, as you know (but have been profitably riding the bull while I wait!).

So how close are we to that top?

Here is my latest take on the Elliott wave picture in the Dow

A small degree wave 3 high (green bars) was made on Wednesday and since then, market has traced out a lovely A-B-C corrective small degree fourth wave (the green bars) that will resolve in the green wave 5 and purple third wave probably next week.  When that wave tops, purple wave 4 will result in a decline of several hundred points at least.

Finally, when purple wave 4 turns, a new rally phase will take the market up to new all-time highs before putting in THE TOP and the Great Bear will take over.

There is any number of possible catalysts that could mirror this upcoming change in sentiment – and David Stockman has listed a great many.  But at the heart is the huge pile of debt that permeates the markets and the economy.

But basically, the ‘easy’ money for the bulls has been made – or nearly so.  It is time to start planning my exit from my long positions and to prepare for a decent pull-back in wave 4.

Trading the dollar with Mr Elliott and Sr Fibonacci

Here is the long term wave patterns in the US dollar

It’s quite complicated and definitely not textbook, but these labels fit the action best in my view.  The key wave is the long and strong red wave 3 which contains its own clear five up.  From the red wave 4, we are now in the final red wave 5 up.  When this wave tops out, there is great potential for there to be a massive momentum divergence – and a hefty decline phase (in a large A-B-C?).

This chart is showing us the dollar remains  in a strong upward trend, so now let;s look at the weekly

Here we can see the market is in the final wave 5 of 5 which will produce new all-time highs.  The conclusion? The only way to sensibly trade is from the long side (until proven otherwise).  A few weeks ago, the dollar was strongly rising in purple wave 3 but when it topped, how can we discover a likely ending for purple wave 4?

We have dealt with Mr Elliott, now let’s introduce Sr Fibonacci.  Here is the closeup on the daily

I have drawn the Fib levels off the major red wave 4 low and that gives me the likely turning points for purple wave 4. The 9925 level appears a reasonable choice because not only is it at the 38% level, it is at the chart support level provided by the highs shown on the weekly chart.

And right on cue, that is precisely where the market turned last week – almost to the tick – and that is where waiting buy orders were touched with very close stops required for a very low risk trade with high probability of success.

That is the essence of successful trading – finding high prob entries with close stops.  Keep doing that and you will be one of the top 1% of traders.

Of course, nothing is certain in life and trading, so what happens if this budding rally fizzles out?  By using my Break Even Rule, where stops are moved to entry price after a decent move in my direction, the worst case scenario is that the market takes me out for zero loss to my capital.

If that occurs, I will know that my wave 4 low probably lies a little lower down – perhaps at the 98 level at Fib 50% – and there I will repeat the process using a close stop.  In the meantime, I am on the right side and have my insurance in place.

ANNOUNCEMENT

I am planning on doing something on YouTube with the video format soon – details to follow.