Bottoming Process Confirmed - August 29, 2011

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We are seeing growing evidence of a bottoming process taking shape at the heels of the 20 DMF’s buying stages progress. Friday closed with a stage 3 buy signal confirmation. Now that this stage 3 is confirmed, the probabilities of a signal failure are much diminished.

Technically, Friday’s IWM opening bottom bounced right on the (65,5) volatility stop for the first time since the August 9 low, indicating that volatile intraday downside moves can be seen from now on as buying opportunities until the next failure of the stop to act as support.

A bottoming process always presents the risk of some violent retracements to retest the recent lows and it often “feels” like a crash becomes unavoidable. When the market is operating in an illiquid environment, prices have to travel farther to find where the remaining liquidity is hiding. This tends to produce False Evidences Appearing Real or F.E.A.R. for many human market participants. An objectively programmed participant like the IWM robot is immune of such illusions: it has a trading strategy and a plan. Its rules are rules for a reason and it is never afraid to execute them. It has an optimal trailing stop at 63.85 where it will cut losses short if necessary, otherwise it is programmed to give the trade maximal chances of letting profits run. It is not influenced by the outcome of any one day because it only has the ability to think in probabilities.

Today’s probabilities for Expected 3D gain are: +1.38% from the previous day's close, with a win ratio of 68.7%. A secondary entry at the buy limit (68.74) remains attractive just on top of the first strong support cluster and around MS3 (68.77), a level that is normally expected to contain 95% of August price moves. This support cluster also includes QS3 (68.17) and SS3 (67.70), themselves expected to contain 95% of quarterly and half-yearly maximal moves. Since IWM already traded many days below these levels, this configuration supports the bottoming process scenario. From a multi-pivot standpoint, it certainly looks like an important bottom has already been made for August but also for the third quarter and second semester.

The next big resistance is waiting at the yearly pivot (or yearly equilibrium price) at 71.84 which already acted as resistance in mid-August. This is 4% above Friday’s close and there are no significant floor obstacles up to that level. Note also that IWM’s relative strength to SPY has closed above its 10-day moving average, another confirmation that a bottoming process is successfully under way with growing appetite for riskier small-cap stocks usually seen just after a bottom.

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SPY bounced too above the (65,5) volatility stop before regaining the yearly pivot (117.60). It is starting the new week above a relatively strong (23) support cluster. Here, the major floor resistance is expected around QS2 (120.79) or 2.65% above Friday’s close. This also marked the mid-August highs and is the floor level where to watch price behavior to gauge a potential breakout.

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QQQ is already approaching its mid-August highs around QS1 and SS1 (54.00) just 1.67% above Friday’s close. This can explain some of the weakness in NDX cumulative TICK that was reported by Paul in his GGT forum analysis. I think that QQQ may calm down a bit while IWM and SPY do their catching up efforts. But watch out for a decisive QQQ breakout above 54.00 as it could lead to either a strong reversal or a fast runaway up move for the overall market.

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The settings from the GDX robot remain desperately neutral. But GDX was once again victorious above SR1 and QR1 (62.12) after Thursday’s violent shake out that almost hit the trailing stop at 58.53. The multi-pivot outlook is extremely bullish once again as there is no major threatening floor resistance before QR2 and SR2 (69.65). Total cluster resistance strength is only 9 against 36 total cluster support strength!.
Billy

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