Let the Price Action Guide You

 | Nov 20, 2012 | 8:35 AM EST  | Comments
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The four most dangerous words in investing are 'This time it's different.' --Sir John Templeton

The market finally saw the big oversold bounce Monday that many have been anticipating for more than a month. The action was particularly solid and even managed a late uptick and solid close. The big question is whether this action marks a bottom that will take it back up as the year winds down, or is this just a bounce that will be used by bulls to escape positions and by bears to reload shorts?

Technically, these bounces should not lead to straight-up moves. The thinking is that downtrending markets create a crowd of folks anxious to sell if they can escape with reduced losses. That is what overhead resistance is all about. People are inclined to escape stocks they view as a mistake. After suffering through ugly losses, they are more likely to sell positions as they break even. Thus, bounces after a strong downtrend tend to be sold.

That is the theory, but since the market crash in 2008-2009 there has been a strong inclination for the market to go straight up after a downtrend. Look at what happened when it corrected in the spring. It topped out at the end of April and went down all of May. Then there was an intraday reversal on June 5 that was similar to what we saw this past Friday, then a big follow-through day on June 6 that was similar to what we saw yesterday. After that, the market never looked back. It held on to that big gain, and after a little backing and filling a couple of weeks later, it was straight up all summer.

Very similar action in October 2011 led to an even more impressive straight-up move that lasted six months. If you go further back, there are at least a half dozen more examples where fading the big bounce after a breakdown did not work.

So should we be looking for clear sailing back up again? Can this market pull off yet another V-shaped move that squeezes the bears and leaves the underinvested bulls scrambling to find long exposure?

One big difference this time is that we don't have central bankers providing the catalyst that they have the last few years. Time and again this market was saved by more Fed-induced quantitative easing or some sort of European bailout of troubled countries. The bears were consistently run over once the central bankers went to work and the upside momentum was boosted even more as computerized trading kicked in.

We no longer have the potential for another round of very powerful quantitative easing, but what the bulls have this time is hope that the fiscal cliff will be resolved. This sort of news may not have the same lasting impact as liquidity injections on a regular basis, but it will remove uncertainty and that will definitely help the market.

Another thing to keep in mind that boosts our chances of a V-shaped move is that we are entering the strongest time of the year seasonally. Some are concerned that coming tax-law changes will impact that as folks lock in capital gains before the rates go up, but there are likely to be motivated fund managers who need to make up relative performance.

I'm not predicting another V-shaped move, but I am keeping the possibility in mind. I'll let the price action be my guide and, if yesterday's gains hold, I'll be more trusting of further upside.

It's very quiet start this morning and we'll see if there is much interest in buying a mild pullback. The biggest problem I see is that there are few good charts, but if we can stay steady for a few days, the problem will be corrected.

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