XLF/Financials/FAZ

The thing about a top is many times you don't know it's in until after the fact. We live at the right edge of the chart, that's the one that doesn't tell you what happens next in the plot so if we were to take for instance the 2007 top at the right side of the chart, how many of you would have been able to identify this as a top?

 Judging by price action alone all you would have known at the 2007 top is the SPX just made a new high, this is why we need help from indicators (ideally the kind that shows us what the market missed), breadth indications, etc.

There's a lot of psychology involved in investing/trading, which is why I consider it one of the most spiritual exercises you can engage in, "Know thyself" or die in the market. For instance, did you know that most retail investors will lose everything they made in a bull market? There have been numerous studies, I've read several. I think one reason is they truly believe, "This time is different". It's easy to fall in love with stocks or a market when you've made money, it's hard to accept that it's over and bear markets move approximately 3.3 times faster than a bull market which doesn't leave you much time to make a decision. Also once losses start acruing, there's a cognitive bias that retail investors use which sounds something like, "well as soon as the market gets close to where my break-even point is, I'll get out", this is the basis psychologically of resistance and the truth is, the market almost never does what they hope. In fact most investors will finally give up and sell at the bottom of a bear market. Even professionals are not immune to this. You may recall me sharing with you the interview I saw on CNBC at the market top by the author of a book called "Dow 20,000", even then no one including (if we are to believe it), the F_E_D including Yellen saw that bear market coming.

From a Professional Fund's site, note the date...

July, 2007 — S&P 500: 1503

Market Outlook Memorandum

Our “Top Ten” Reasons the Bull Market Is Far From Over

Since the Fed finished raising interest rates a year ago, stock prices have risen by about 20%. In this Outlook we review ten reasons why we think this bull market can last at least two more years. These include: (1) market history of bull markets generally lasting about two years following mid-cycle economic slowdowns like we currently are experiencing; (2) the world economy remains healthy with contained inflation; (3) bull markets generally do not end until 6-12 months after the Fed resumes a tightening program; (4) stocks are fundamentally undervalued; (5) there is an estimated $1.5 trillion of private equity funds awaiting investment; (6) corporate share repurchases will continue to boost stock prices; (7) the active mergers & acquisitions market will help to raise stock valuations; (8) investor sentiment generally remains cautious, which is a positive factor; (9) the recent market advance has been quite broad, indicating much strength left in the market; and (10) weakening home prices could attract retail money back to stocks from real estate investing. Consequently, we think stock prices have the potential to advance by roughly 15% over the coming year.

 Sometimes we need some extra help, this is the daily chart of the exact same SPX 2007 top with one small difference, the 3C divergence at the very top.

Breadth was horrible as well, not as bad as it is now, but it was a screaming red light.

If we look at the SPX now, we see a very similar divergence, this is far from the largest, but a timely one on a daily chart.

Do you see the change in character? The Broadening top and the concept of common technical price patterns like a Broadening top being head faked just before they reverse ? The top formations are real, it's the head fake moves that are used to convince traders that they are not real, that they have been nullified, it's the ultimate bull trap whether on a 1 min chart or a weekly chart, the concept is exactly the same.

Here's a 30 min chart of XLF/Financials. You can see a positive divergence and the distribution of a common cycle in the red box, but take a broader look at the same chart...

 The October lows, a time and just before the October lows WHEN EVERYONE WAS CALLING A MARKET TOP IS THE ONE TIME I DISAGREED FOR THE SIMPLE REASON THAT TOO MANY PEOPLE WERE CALLING A TOP AND ALL ON THE SAME SIDE OF THE BOAT. Wall Street will almost always flip the script as the market is a zero-sum game, if everyone's on the same side of the trade, how can anyone make money with no one to lose it?

In any case, the broader picture is that XLF looks to have topped in December.

If we look at this as a common H&S top (and they never look like the textbook which is why we use volume confirmation), we see the 3 areas I'll short a H&S top and the one area I will now. This isn't something I just made up, I've held this as a major concept for over 2 years once I identified the pattern that plays out over and over and it's all based on the predictability of technical traders and TA dogma. Technical Analysis teaches to wait for confirmation, ideally according to Technical Analysis which identified H&S tops almost a century ago so they are well known, the break of the neckline at the red X is where you want to short a H&S top or if it bounces back toward the neckline, but does not cross above it.

I'll short a H&S at the head (1) if I can identify it that early, at the right shoulder (2) and NEVER at the break below the neckline, this is exactly what everyone else does and gives Wall Street every reason to shake those traders out as their positions and stops are as predictable as the sun rising in the morning. We identified the "Shakeout which takes prices back above the neckline after the initial break below it, which is where the shorts' stops are, either right above the neckline or right above the right shoulder. Additionally TA teaches that if a major price pattern like this fails on you, reverse your position so as they are stopped out of their short they are entering a long that they'll soon be stopped out of as well. 

The H&S is real, it's the shakeout that confuses things and often makes traders 2x losers on the same price pattern, actually 3x as they often miss the short so the last place I'll short a H&S top is after the shakeout has run its course above the neckline and after the initial break of the neckline as traders are starting to go long the asset again.

 In 2010 there was a large H&S-looking price pattern that a lot of traders were taken in by, but it was not a real H&S and shot up to new highs.

The reason they fell for it is they only looked at price as the art of volume analysis is long gone. A true H&S should show increasing volume on declines and declining volume on advances. This is a custom indicator that cumulates volume so it is easier to track, as you can see volume rises on declines and falls on advances like the right side of the chart now.

 We also formed an Igloo/Chimney price pattern here this week. You may recall my FAZ pullback set-up from last week, Leveraged ETFs / FAZ.

In other words, we were looking for a bounce in XLF (chimney) and pullback in FAZ, that's the trade set-up from last Thursday.

The intraday XLF charts aren't looking very good here.

However, some of you have asked if I still like FAZ after all this time and the answer is yes, this is a daily chart and it's not often you see a leveraged inverse ETF give a leading positive signal on a daily chart.

The 4 hour chart is just as interesting and inspiring, note the October market lows (highs for an inverse ETF) and what has happened with 3C since.

On a closer term 60 min chart, this is the area of the FAZ pullback I have been watching, note both divergences and the stronger second which usually means that both are part of one larger base.

FAZ 30 min on the latest cycle, not only has price flattened out and formed support, but the 3C indicator is calling this an area of accumulation.

 In last week's FAZ trade-set-up I said the 17th looks like the low, but look for a pullback and a positive divergence in to that, that's exactly what has happened since last Thursday.

Intraday, everything has gone sideways for the market, but FAZ's chart is leading positive, thus I think we've pretty much hit the area of the trade set-up we were looking for , otherwise I have no problem with FAZ long term as a trending trade.