Fibonacci sequence is a mystery to some, a curse to others, and a Godsend to a few. To me it’s a marvel, as is the clarity of a bee’s honey comb (natural Fib sequence). To embrace it, or to grasp the Golden Ratio, is to embrace the notion that the market has more symmetry than most are willing to admit. However, since I have centuries of French Catholicism locked up in my genes, it’s easy to believe that sin and redemption, Good and Bad, are balanced, or symmetrical in human existence. Therefore, I expect to see repetitive patterns in human behavior as mirrored in our charts. After all we are measuring and exploiting greed vs. fear, as they constantly repeat, aren’t we?I regularly look for Fib retracement levels on the weekly SPY chart just as I look for OB/OS readings on the 5-week RSI and bullish/bearish divergences on the weekly MACD-H. These are my little friends, my play pals, the tools that for good or bad, profit or loss, I hang my hat on week after week. Last Friday, April 16, SPY traded right into the 85-87 range, which was the .786 Fib retracement from the Oct. high of 159 to the Jan 65 low. It also corresponded with RSI hitting OB, and MACD up there too. The little pals were tugging at my arm, whispering that the bear mojo was starting to stir. Weekly price was at a Fib resistance, 5-week RSI was OB and the rally was 6 weeks old, about right for some time symmetry.The daily chart was just as vivid. Friday’s price action was classic churning, lots of Sturm und Drang but in the end a Little Worm or false breakout. The daily momemtum boys–RSI, MACD and FI–pointed, respectively, to short-term overbought on the RSI, declining on the MACD, and a wimpy lack of juice on the FI. To make it more interesting, Friday was the intersection of some long-term trendlines. All my little pals, the ones I grasp when I shut my eyes and dive with Alice down the rabbit hole, said the same thing, buy the 2X inverse ETFs at the close. Along the way down, the hooka smoking catepillar flashed a smile and mouthed, “while your at it grab some of that 3x FAZ.”Now, of course, with the SPX down 37 points at Monday’s close cash is the position of choice, the Mad Queen is strutting across the chessboard, the Greatfull Dead are on their way to Terrapin Station, and the little friends are skipping back to that magical place whence they came. We are left trying to figure out how far down is down for this retracement. For that I have no answer, but eventually, we’ll get to OS and it will be time to rustle the leaves, play the flute, and invite the little friends to saddle up their hobby horses and go fat rabbit hunting again. But for now, I don’t plan to buy the dips, but look for chances to sell the rips.

Trading is about price movements, but really we’re measuring human behavior ruled by gut-wrenching fear and elated greed. The VIX, which is a ratio of puts and calls, measures emotional volitality–it moves up, sometimes violently when fear riens and price declines. When the VIX declines, price is stabilizing and usually rallies; the SPX price bars narrow and everywhere it is happytime. The VIX is an easy way to measure the emotional extremes if you use it properly. I say easy, but most traders think of it like the RSI with absolute highs and lows. Not so, the VIX is a relative measurement and needs to be compared against a 10-day MA to give accurate signals–all of which is for a future discussion.But today, I want to point out a truly remarkable development on the VIX’s weekly chart–something that foretells a major move. After the spike to 90 in October 2008 punctuated the market’s big move down to SPX sub-800 (the VIX moves opposite the SPX–VIX up, SPX down, and vice versa), the VIX corrected, finally settling in a range about 50% of the move. We’ve been bouncing steadily between 35-55 week after week for about four months. While it may not seem like it, the VIX has steadily lost volatility indicating that neither fear nor greed is at extremes. Now, we are entering a rare squeeze on the weekly chart, which portends a major and probably violent move in one direction or the other. Though the indicators seem to be on the lowish side, these sideways moves often create unreliable RSI and MACD readings. So, we need to wait a week or so to fit this piece of the puzzle into place, but past experience says that come what may, either greed or fear will soon cause our little world to tremble and shake.

This is an excerpt from The Big Picture.com:Thomas Lee, US Equity Strategy at JPMorgan writes: “Believe or not, retracing 12-year lows for the Dow is an incredibly rare event. Besides the retest of 1997 lows seen on Monday, this has only happened two other times, on April 8, 1932, and December 6, 1974.”Given the rarity of the event, it is worth taking a closer look at the past instances: The 12 year low in 1932 was ~three months before the end of the bear market. In 1974, it was exactly the low for that bear market.Dan Greenhaus of Miller Tabak adds, in both cases, “the economy continued contracting beyond the bear market bottoms; this is typical of recessions. Unemployment continued rising and GDP remained weak. The 1974 Bear market ended in December, but GDP contracted even in the Q1 1975 at a 4.7% clip

Bottoming Process

I’m curious by nature; which is often a flaw as a trader, when precision and timing mean more than flights of fantasy. However, over the years my curiosity has lead me into a very fertile area of inquiry for trading–volatility. For trading, volatility usually describes violent and quick changing price moves–think long bars on a price chart, not nice tight narrow-range ones.Volatility is usually a function of emotion overruling reason, and therein lies profit. Good traders are creatures that understand fear and greed; profitable traders soon figure out ways to exploit this constant conflict in market behavior. The other extraordinarily profitable characteristic about volatility is that, unlike price, which follows a bell-shaped reality and is given to mean reversion, volatility is extreme reverting. This is probably worth repeating, because there is definitely money to be made in this insight (which comes from John Bollinger, BTW), volatility is extreme reverting, jumping from wild swings and long price bars to sudden pauses and short price bars, not a gradual sequential progression at all.The chart of CAL clearly shows this behavior. Look at the bars on the right side, several long bars separated by three relatively narrow bars, which I’ve marked off with lines–looks like a small symmetrical triangle, doesn’t it? Well, it does and it is exactly that, a period of indecision or confusion. Traders conflicted that the long move down from 21-16 was a trend, or an oversold buying opportunity. This push-pull tension went on for three days right at the 200 DEMA (red line), before fear overwhelmed them, the down move continued as the Bears took command and drove price to 13.The sell short point is at the break of the third bar, a dime under the low or around 16.48. Since these little triangles, or consolidations, or continuation patterns, show up about half-way in a move, the target is sub 14. In my case, I closed out my position at the end of the first down bar, about 14.5. Notice that volume contracted during the triangle, and exploded as price fell out of it–classic behavior as fear set in once more.I look for all sorts of volatility contraction set ups–triangles, squeezes on the daily charts, but really like them on the weekly or monthly charts. These little battles between fear and greed usually show up half way through a move and routinely make money. I take them in either direction, but especially like them to appear near 200 DEMAs where the big traders and hedge funds like to hunt–just slip into their wake; but remember to jump first before they reverse direction.

Most traders know that there’s no end of ways to measure if the stock market is overbought or oversold. Hours can be spent pondering this basic, but critical condition. For most of my work, I use a very short, 2-day RSI momentum indicator. This serves me well for my hit-and-run trades. However, it pays now and then, to step back and get a grip on the big picture. So, I’ve included a multi-year monthly chart with 12 and 24-month EMAs above a 12-period RSI momentum indicator.For 5 years, from April 2003 until February 2008, the monthly price bar hugged the 12-month EMA like a dog on a chain, only drifting away for a few months rally now and then. In fact, we could be comfortably retired if we had bought the SPX futures when the 12 month EMA crossed up through the 24 and sold them when it crossed down through the 24. February 2008, of course, is another story and the market crashed almost 700 SPX points from 1400 to a low of 740. Now, we’re bouncing off the 800 level, testing the support which comes from the 2003 lows.Millions of dollars are being bet on whether we hold this level or not, a wager that keeps the daily action choppy and uncertain. The 12-month EMA is plunging to meet price, but price is way, way, away. It should be clear that price is stretched further from the 12-month EMA than most of us have seen in our lifetime. The 12-month RSI is also at an extraordinary low–in fact, I saw a monthly chart that went back to the 1920s and the 12-month RSI wasn’t this low then. So, big picture, we’re historically oversold and overstretched and a solid argument can be made that someplace along in here we’ll rally, perhaps all the way back to the declining 12 month EMA around 1000-1100. I’m not going to make that argument, however. I think, most likely, we trade sideways, bouncing up and down driving investors crazy. Once everyone gets bored and sick of the sloppy action, then there’s hope that we might turn up.

Grant C, one of our winningest Spikers, has sent in this contribution:More about bottomsI thought I would revisit my late November 2008 post about how the 2002 bottom formed. As I said in that post, reviewing the 2002 bottoming process, which took almost a year, is extremely helpful in viewing the current market action. Both charts are weekly Candles with 5, 20 and 40 week EMAs (25, 100, 200 day EMAs) and MACD-H indicators.In 2002, the market’s first stab down was in July, taking price deep below the Bollinger Band and forming a long Hammer candle. We rallied for four weeks, coming close to the declining red 20 WEMA (100 DEMA). Price then crumbled and for seven weeks we sank back to the lows, forming a major weekly MACD-H bullish divergence. Note also that on the retest, price stopped inside the Bollinger Band, confirming that the retest was successful, and the bottom was in. From the retest, we surged back through the declining 100 DEMA and into the declining 200 DEMA, which stopped the rally cold.The 2008 bottoming process shows the mid-October stab to the low, outside the Bollinger Bands. It then reverses with a Hammer-like candle with a tail. Then for 5 weeks we’ve recovered with more sideways action than upward movement. Still we’ve managed to come fairly close to the declining red 100 DEMA. Guess what’s next? Based on the 2002 model, we probably break support here and drift downwards for 4-6 weeks until we retest the October lows.As our comparison shows bottoms are processes consisting of time and price. Bear markets are painful, they wear on investors, take their money, and finally leave them disgusted and looking for more pleasant amusements. To be a successful trader in this environment takes patience and a game plan. A sense of history also helps.Grant C