Sentiment Update

It has been a ride so far.  But given all the new highs being made - and the fear of heights is in anyone - how is sentiment and asset allocation doing?  I have these long term charts I want to share with you and as you know, these charts change very slowly.  First the long term sentiment:

You can interpret as well as I do.  The decline in sentiment with rising prices I view as bullish.  The same happened in the 90s but also more recently in the 2004- area.  I think the key is that sentiment does not drop too far, but healthy fear from the heights (or murky outlook in the economy) is usually best for the stock market to sneak prices up.

The asset allocation:

Current asset allocation is similar to 94.  If we would repeat history we would get one year of consolidation. Given the recent run up for more than 3 years this would not be surprising.  The next leg up could be fueled like in the 90s by shifting allocation away from bonds - which is rather high - into stocks.  That's a slow process though but it would not surprise me either given the low return in bonds going forward.  People may be enticed to invest in the stock market encouraged by the recent gains.

As always, do your own thinking ...

Short term sentiment Aug 2012

The short term sentiment graph of the AAII survey done every week shows that we are at a sentimental bottom.  Using this as timing of course is not really possible as this graph changes really slowly (every week a new data point is added and the green line is a 10 week average).  I would say though that trades should be on the long side even though the market seems to be at (upper) resistance again.  I personally sold my longs and plan to by them back on a pullback - but I use other short term indicators like the CLX (3day and momentum) for such short term trades.

Market bottom

Other evidence for a possible market bottom:

The 10 day CLX shows a pos divergence with market action and is at acceptable low levels.

The 30 day CLX also shows a good spread between the 30 day CLXpp and the 30 day CLX. This is what we want to see on a market bottom. It could go a little lower but where it is kind of aligns with the resistance line I drew.

The equity P/C ratio also look good as it was in the past. A better picture possible shows my own indicator, the PC Vol. (below) where you don't have to guess so much about the spikes :)

Good luck trading!

Europe and Spain

The news about Spain & Europe recently were quite negative (well, for a reason) which resulted in investors being quite scared. Here is a short term sentiment chart that shows that we are down to 'resistance' (green line)

Longer term sentiment doesn't change much and as I said in a previous post does not show any exuberance. FYI here it is again:

It is unlikely given the long term sentiment alone that we would have a meltdown coming.

Many indexes are at important resistance. As an example I have VGK.

It is right at the resistance line and this week started to move away from it. Bears are drooling though since the pattern from 2009 until 2012 resembles a head and shoulder pattern and if the neckline breaks the assumption is (or the target would be) the 2009 lows.

I bought here though for 2 reasons:

• As described above the sentiment does not support a meltdown and is at lows.
• VGK being at resistance also gives me a nice (close) stop level in case things go south.

Good luck to you!

High Risk

Is there such a thing as a low-risk entry? I seriously wonder ... The current market situation may present for some the perfect entry. Fear is high - the contrarian among you is excited - and a sizable correction has been done with the market at support (Fibonacci and resistance lines).

Now, sentiment may be at a low but there is one notable divergence happening as visualized by my scribbling in the picture. Sentiment went sour weeks before the market declined. If it plays out like last time, we will see another sharp correction lower in a short while. Many think that at least a retest is in the cards ... so much for a low-risk entry.

Forex Trading Systems

I was shocked recently when I visited www.myfxbook.com. Let me explain: myfxbook is used to 'show off' automated trading systems. The website tries to verify the trades done by the trading system and that the account is not fake. It also has a search facility for finding those systems and shows if the system was a real account (real money at risk), a demo account (virtual money) or simply a back-test!

I was shocked by how readily people jump on new systems with a real account (or demo account) that shows a history of maybe 3 months of data. Sure, the profits these systems produced were enormous - but that alone should be a warning sign! These systems are highly optimize for a single currency pair and have 'expires soon' written on them. When they fail, they fail BIG.

Now I am no expert on trading systems but from the back-testing that I have done I can tell you that no system always works and the more they are optimized the harder they fail. The markets do change ... Take for example a simple moving average system that gives you buy/sell signals (take any methodology). You will discover that

• It will not work on all currency pairs and shows huge losses on some (hint: this is how the system behaves when it does not work well)
• If it works great on one currency pair, it will not work on all time frames (weekly, daily, 60min, 15min, 5min, 1min charts)

When you see the system fail miserably you need to ask yourself: How can I design the system so it fails gracefully or reduces losses when 'out of sync'. Since a simple system like that (and I think any system) does fail on many currency pairs and time frames, optimizing this for a single currency pair & time frame makes it look stellar on paper (you get a real smooth profit line) but makes the system less robust because eventually the market will change. Think for example of the stop-loss the system may be using - it may simply be too tight in the near future. Or maybe it has no stop-loss and hopes for the better :)

Be careful!

Europe

The market did surprise me this past week quite a bit. Given the dire news that came from Europe about Greece and Italy, the market stayed very strong. Here is an update on the last graph I posted.

It seems like the 30diff broke the resistance line. The 30CLX also is showing great strength.

The 30CLXpp is also showing great strength. Yes, they all seem to be on the upper bound, but if you compare that to previous bull market advances this by no means indicates a pullback must come.

On the sentiment front the 2CS is doing great as well. Plenty room for it to go down and mark a top.

Short term sentiment may be a little high (taking AAII sentiment).

We never get a perfect picture I guess. My feeling is if we ever get I will be way too scared to actually buy :)

Longer term sentiment as measured by asset allocation also shows that we are not at a top nor bottom. Since we 'just' came from a bottom I would imagine a meaningful top being make here before another multiyear market decline. It doesn't look this way - in face, I do like the high cash % and bond %!

So, what do I think happens? I go with the flow. Looks to me that we may break out to make new highs next week, so I simply use a buy stop which gets me in on further strength.
I expect news from Europe to keep everyone scared while the market does what its going to do - whatever that is.