I Can't Find a Crash without a Retest

For those of you who have been fully, or even partially invested the entire way down, I am sincerely happy that you were able to make back some serious money the last few days.

That said, there was plenty of evidence in 2007 and early 2008 to tell you that it was time to get out of stocks and protect the hard-earned gains of the 2003-2007 Bull Market.

The biggest rallies have come in Bear Markets. Bear Market rallies make you feel good, scare you about being in cash, suck you in and then crush you. Buyer Beware!!

I actually started shorting some this afternoon. I expect a retest of Friday's lows.

I can't find a crash that didn't have a retest!

Look at the 2-day rally following the Crash in 1929. See how the market sold off and actually undercut the initial low?

The same thing happened in 1946. The Dow crashed and then put in a series of sharp rallies and retests. September - November 1946 looked like a really frustrating and unproductive time to own anything.

The Crash of 1987 looks a whole lot like the Crash of 1929. The crash was followed by a sharp, 2-day rally. Then the index tested the lows over the next week or so.

In 2001, the S&P 500 had two major selloffs (crashes). In the first (Green Box), the S&P rallied sharply for a few days and then retested the low of the crash.

In the second (Black Box), the S&P rallied for a few days and then sat around for 3 days (Black Arrow). While sitting around, price corrected 30% of the first move up, and support was easily defined for a clear stop point on any buys.

I am not interested in buying a spike down, and I am not interested in buying a spike up. I want to wait for a decent entry point, with definite risk.

There were also two crashes in 2002. The first had a 1-day pullback (Red Arrow), which retraced about half of the first-day's gains. A few days later, there was a nasty 3-day selloff which retraced a big chunk of the first rally.

After several weeks of rallying, the market rolled over and ultimately undercut the lows of July (Black Arrow). This testing and retesting is a part of the bottoming process.

My brother once told me that the markets go to the most obvious place in the most painful manner possible.

The most painful scenario right now is a sharp selloff to retrace some of the massive gains of the last few hours of trading.

That would be enough to scare some more people into selling their stock before a more meaningful rally. Remember, the average rally from these emotional extremes is 24% over 8 weeks.

This is an emotional time. The more information you have about historical precedent, the better you should be able to navigate the current market.

I think we are in a Bear Market rally of unknown price and duration. History tells me that there will be a retest of the recent lows, or at least a decent retracement of the first rally off the lows. It is at that time that I will be able to determine if I should be buying and how much risk I may be taking.

Clients know that I have been heavy in cash the last 12 months and that affords me the ability to pick my spots.

The Casino Was Open on Friday. Now What?

On Thursday evening I wrote the following -

"I would not be surprised to see the tradable bottom show up tomorrow as the news of the Lehman CDS settlement evolves tomorrow. I will be looking for a capitulation tomorrow morning. If it shows up, then I may put some money to work."

Oh, where to begin…
On Wednesday, the S&P 500 took out 970 and tanked 130 points in about 90 minutes of trading. That’s like a point a minute or 13.4%! Brutal! That’s 53.6 years of returns in the current 3-month US Treasury…

Here’s a chart of the Dow Jones Industrial Average on Friday. Each red and black bar represents on minute of trading.
Down about 700 points in 8 minutes
Up 500 points in 8 minutes
Up about 850 points in 30 minutes
Down 450 points in 5 minutes

The casino is open! I am not interested in gambling, so I sat on my hands on Friday.

A tradable low may now be in. If it is, then I will wait for sound entry points to buy. I am not real keen on buying into this news-driven environment, especially ahead of a weekend.

The S&P 500 spiked down to the -35% level. I think it would be natural for the S&P to spike up into the last breakdown point (970), before rolling back down to retest Friday’s lows. Of course, that is on the assumption that 908 can be cleared. A successful retest is what I am interested in buying.
I am trying to carefully measure how I write the next sentence. If (IF) in the next few days, the S&P 500 takes out the lows of Friday (840) and cracks hard like it did from 970, then it is my opinion that the Fed will call a “Banking Holiday” and close the banks for a few days. During the time the banks are closed, I would expect the Fed to nationalize the banking system and offer existing shareholders of bank stocks warrants in these banks for some point in the future when they are sold back into the markets as public companies again.

I would also expect the Fed to guarantee all bank balances to convince individuals and institutions to not take their money out of the banks. We really are at that stage right now where the system is on the brink of breaking and that is why I am looking for opportunity.

On the 30-minute chart I show each 5% band (black dashed lines). The lows band (840) is -35%. The top band is -15% (1100).
For now, the S&P is merely trying to find a bottom in the 840 – 910 range. If this level holds, then I would expect the first real resistance to come in at 970 – 1020. If the 840 low holds, then we could see the rally in the S&P work its way up into the 1100 range over the next 8 weeks or so. The weaker the bounce, the worse the next leg down will be.

One thing I am always interested in is determining what is acting stronger than the overall market. Take a look at how Apple and Deere have traded the last week. Both were able to hold up rather well for the entire week, even while the S&P 500 was breaking to lower and lower lows. That is a potential positive for these two companies. I own neither and sold Apple at $184 on May 5, 2008.

970 Broke, Leading to Another Leg Down

I noted the following yesterday –

“The S&P tried to find support the last two days at 970. That level had better hold, or the markets will start yet another leg down”

Here is the chart from yesterday, updated for today’s action. 970 got taken out and the S&P 500 did a nosedive into the close, falling about 60 points (-6.2%) in the last 90 minutes of trading.


I also noted the following yesterday –

“Sellers continue to swamp buyers and the markets continue to sell off hard into the close each day as mutual funds sell to cover what are no doubt massive redemptions.”

This is classic Bear Market action. I think we are in the “capitulation” stage, where people wake up at night in cold sweats and sell because they just can’t take it any more. The last few days of selling are always nose dives. So it can be so very costly if you are even just a few days early. That is why I want to only buy on a low risk set up.

You will not want to buy at the end of a Bear Market or a selling panic. It is human nature. My goal with this blog is to get a continuous commentary going to let you know how the markets evolve and how those internal changes in the markets will tell you when it is time to be buying and not selling.

As the markets were topping last year, I went through the changes with clients in great detail and we were able to take defensive measures to protect capital. Some chose not to sell. I am sure that they will listen next time...

I can now buy the markets at a 37% discount to a year ago. Are you kidding me? Those who raised cash in late 2007 and the first half of 2008 are now years ahead of the game. Those who didn’t may have to delay retirement for a few years.

I think people grasp onto the “buy and hold” mantra because they have not found how to determine when it is time to be buying and time to be selling. Just as the markets gave a lot of clues as they topped, they will also give lots of clues as they bottom. My goal is to keep you informed, so that you are interested in buying what big money is buying, even though the idiots on TV are telling you to sell – just as they were telling you to buy the first 4,000 points down on the Dow! Remember, “Buy low and sell high”.

I did zero trades today. Then I went home and took a long nap. I am exhausted. Interpreting this intra-day volatility is hard work. Even with the hard work, I may still miss the low and not be able to trade whatever bounce we get. My concern now is that the next rally may only carry up to 970 on the S&P 500.

This Bear Market is of Epic Proportions

I figured that we had a decent chance of a crash on Monday, but this is getting ridiculous.

I only have reliable charts back to 1980, but I can tell you that since 1980, there are only 3 occasions where the markets got to this level of extreme selling – October 1987, July 2002 and this crash.

Today, the markets had an excuse to rally, with several Central Banks cutting interest rates over night and Wal-Mart being less bearish than expected, but the markets cut through support like it wasn’t even there. Sellers continue to swamp buyers and the markets continue to sell off hard into the close each day as mutual funds sell to cover what are no doubt massive redemptions.

Here is the market today

Here is The Crash of 1987

As you can see, The Crash stopped below the -25% band (Black Line). I have no clue where the market bottoms on this leg down. Anybody who tells you they know where things will bottom is making it up and you don’t need to bother listening to that nonsense.

But I can use past market moves to see how the market reacted once the selling stopped. In 1987, the S&P 500 fell below -25%, reversed for a few days, then retested the -25% band (2nd Black Arrow), then rallied back to the -15% band (Blue Arrow), then retested the -25% band again, before reverting back into the Mean (Green Arrow).

So the odds are high that after this selling panic stops, the markets will rally and then retest the lows for a while before they make their move back into the Green Line.

The same thing occurred in late 2002, as the S&P 500 spiked below -25%, then rallied, retested the Bear Market Low of July (Red Arrow), then tested the Green Line on several occasions, retested the July and October 2002 lows one more time in March 2003 (Red Arrow) and then started a new Bull Market.


The 1987 bottom took several weeks and the 2002 bottom took over 8 months to form. So I expect this market to see a bottom form over time. There might be a HUGE short term rally once the bottom is reached, but there will most likely be a retest of the lows after this rally.

The other issue I have noticed is that while the market was in these bottoming processes, the Green Line was falling. So when the market finally does revert back into the Mean, the Mean will be a lot lower than it is today. In 1987, the Mean fell 11.5% from the day the market bottomed, until the day the market finally touched the Green Line again.

Today, the Green Line is at 1300. 1300! While the S&P 500 is at 986…
It is just a guess, but my guess is that price and the Green Line end up meeting in the 1150 – 1200 range.

I expect the next rally to be highly shortable.

Today I moved some of my 401k money from cash into the S&P 500 Index Fund. I did not buy a share of anything for my clients. I did the 401k purchase, because I can only buy mutual funds at the close and it is more profitable to be a day early than it is to buy at the end of the day of the bottom.
The S&P tried to find support the last two days at 970. That level had better hold, or the markets will start yet another leg down. IF 970 holds, then I will consider buying it, because the first real resistance is at 1100. That is 14.4% from 970. If 970 fails, then I will wait for the market to try and build a bottom at some lower level and then look to buy a reliable set up.

Did I mention that 976 is the -25% band on the S&P 500 and 1103 is the -15% band? You can’t make this stuff up.


One of these bottoms is going to work. I’m just not sure which one. But I have to treat every attempt with the potential to be a bottom. I hope the bottom arrives soon, because I am exhausted.
The charts of the NASDAQ and the Dow Jones both have similar potential bottoms to the S&P 500. They will most likely all bottom in unison.

Market Roadmap

I know that I am rehashing things, but it is the start of a new quarter, so I wanted to review my Roadmap. This is the chart of the Standard & Poors 500 Index (S&P 500). The S&P 500 ($SPX) is a composite which tracks the performance of the 500 largest companies which trade on US Stock exchanges. As this index goes, so goes the economy. It is a Leading Economic Indicator.

I consider this chart my Bull Market / Bear Market Roadmap, because it makes it easy to see whether we are in a Bull Market and you should be focusing on making money or in a Bear Market and you should be focusing on protecting your money.

Very simply, if the bars are above the Red and Blue Lines, then you should be buying pullbacks into the Red and Blue Lines. If the bars are below the Red and Blue lines, then you should be shorting bounces into the Red and Blue Lines. Pretty simple, huh?

We are now below the lines, so you should not be holding stocks. If you want to try and make money, then you should be shorting rallies into the lines. If you don’t want to risk money, then sit in cash and wait for the next economic expansion.

In January 2008, I alerted clients that the markets had broken down and it was time to get defensive. Those who were late in reacting were advised to sell the first bounce into the Red and Blue Lines.

I made it very clear on a number of occasions this year that I think we are replaying the 2000-2003 Bear Market. This is the second crash since the late 2007 top. The 2000-2003 Bear Market had four crashes. I am not sure if we have two crashes or ten in this Bear Market. But I do know that I will be ready to buy when the Bear Market ends.

I also know that I have avoided the majority of the carnage of 2008. Even with today’s monster rally, the S&P 500 was down 9.21% for the month of September! Yikes!!

In my opinion, you had better know how to play offense AND defense, or you should find somebody who can do it for you.