Navigating The Crash Safely – August 22, 2011

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The robot cannot predict the future. No model or system can possibly do it.

What the robot can do is predict the probabilities and risks associated with given future outcomes. It's like insurance companies: they cannot tell you when you are going to crash your car, but they can predict the risk that you will crash given the right information. The new IWM robot can do the same thing with the market. When the risk of a nearby crash is too high, the robot minimizes the losses by staying in cash. If you lose less, you get ahead of those who lose more.

Actually, because the robot is designed to constantly look for long or short positions, the neutral signal forcing the robot to stay in cash means that a “crash” could happen in any direction. Currently, there is as much risks associated with being short the market as being long. In the first case, the “crash” would be a strong rally from current levels, in the second case, it would be another deep plunge.

So, the disciplined and rational option here is to stay in cash.

On a discretionary basis, you can of course try to trade the very short term noise of the market. With an average daily true range above 4% for IWM, and triple leverage daily true range above 12% for TNA/TZA, it is very tempting to try to catch some of these impressive intraday moves. Some of the robot information can help you in your discretionary decisions.

For example, there is a very weak buying ST/LT edge today and the limit buy entry is 65.23. This entry is of course optimal for a multi-day trend-following entry, not necessarily for an intraday entry, but it is an important risk-reward reference level to keep in mind.

The pattern most important to watch today is the potential double bottom on the daily chart. The first leg of the double-bottom formation (August 9) did occur on heavy volume. This current second leg down is typically characterized by lighter volume than on the first leg down increasing the odds for a successfuk retest of the lows. It doesn't matter where the second bottom develops; it can be a little above the first, a bit below or at the same level.

Just as on August 9, YS1 (64.40) will serve as a powerful floor support with its strength of 8 on a scale of 1 to 8. That’s where the last massive wave of buying programs triggered on August 9 and it was very easy to catch watching the cumulative TICK. I think my own discretionary setup is rather simple here: IWM is on the verge of a potential very strong bounce. Only massive (HFT) buying programs could trigger such an outcome and only cumulative TICK can confirm that the algos were indeed centered on YS1 (64.40) as a reversal point. I will simply wait for a cumulative TICK signal (positive divergence and break above half-day moving average) and try to buy at or below the multi-pivot limit entry of 65.23. Daily S1 (64.32) is just below YS1 and will serve as my initial stop loss level, say 64.29 at worst.

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However, we must be aware that the IWM setup is not confirmed by SPY which is still 3.07% above its own YS1 (109.19) potential bottom floor support.

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QQQ closed below its own potential bottom floor support of Yearly pivot (50.40) but it was opex day and we are in an overshooting environment due to high correlations and volatility. Maybe the double bottom is already in here, maybe not.

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Both for QQQ and SPY, the optimal multi-pivot long entries are much lower than Friday’s close. So, the “cleaner” setup is really present for IWM if buy programs decide to trigger aggressively today. This would be logical with the poor RS from IWM, and we know that the lowest RS assets are the ones bouncing the most quickly and violently from potential bottoms.

For GDX, there is no double bottom or top to talk about. This ETF is now in true trend-following mode and ready to break above the last obstacle of SR1 and QR1 (62.12). It is now more a question of “when” than “if”. Today’s secondary buy entry limit of 60.94 looks very attractive, just above the initial weekly pivot support at 60.54. The trailing stop on the initial position has been raised again to 56.14. The total strength of all floor supports is now 37 between Friday’s close and the trailing stop, so the GDX robot position can weather very adverse pullbacks before triggering any stop exit.
Billy

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Billy, is it just me or have there been, in fact, an extraordinary number of gap-opening days (up or down) over the past few months? I've not seen anything published about this and not sure it's important but thought I'd raise the topic.

[QUOTE=adam ali;15960]Billy, is it just me or have there been, in fact, an extraordinary number of gap-opening days (up or down) over the past few months? I've not seen anything published about this and not sure it's important but thought I'd raise the topic.[/QUOTE]

Adam,

The high frequency of large opening gaps is typical of a short term news-driven market and indecision about longer term trends. Most intermediate term participants are now on the sidelines and day traders are in charge for just a few hours each day.
Those gaps mean nothing and are often manufactured to ruin your best setups, fish for your stops and exacerbate weak participants' emotions.
That's why I have advocated here to avoid holding any position overnight until the robot gives us its next strong signal.
Billy