The Average Investor's Blog

A software developer view on the markets

The Weekly Update

Posted by The Average Investor on Aug 14, 2011

This bear market is developing rather rapidly. Last week we saw a few events of importance, which usually take longer time to develop. First the market downturn reached a bear market definition – 16% drop both on the S&P 500 and on the Dow Jones. This is the definition I use, which I saw first in Jack Schannep’s excellent book Dow Theory for the 21st Century. By the way, this is one of the few books written about technical analysis which presents a method that actually works.;)

The event happened on Wednesday, with the Dow Jones joining the S&P 500 by reaching a 16% decline from the recent highs and thus, a bear market was in place. Two days earlier however the markets went into extremely oversold territory which is typically consistent with a bear market bottoms (the above mentioned book is my guide in this area as well). On the same day, Monday, August the 8th, it seemed to me that we finished a Dow Theory sell signal.

Earlier, on August the 2nd, the S&P 500 penetrated its 200-day moving average and, around the same time, the 20-week moving average. The last man standing is the 10-month moving average, but only because it’s computed at the end of the month (if we do the math today, the S&P 500 has penetrated that average as well).

All in all, we are in a bear market territory, but based on the liquidation sell off we saw last week, the most pain might be behind us and the lows might be already in place. Only the future will tell however whether Tuesday’s extremely oversold conditions were a genuine buy (true most of the time) or one of the few panic liquidations on the way down (what happened in 2008).

The situation is extremely ugly – four years later, we are about 25% below the peak in 2007. Inflation adjusted, the picture is even grimmer – we are bellow the peak in 2000! Even after this stellar performance, we have the same people at the crucial positions running the same rotten policies, so it may take a while longer (I know it will at some point) for the natural animal spirits to take over and cleanup this mess.

The ARMA indicator didn’t fare much better. It was long all the way until recently, turning short on Friday which was a positive day. Currently it stands at -0.58% for the year, still better than the -6.27% for the S&P 500 (excluding dividends). And if you wonder, the indicated ARMA position for Monday is short again.

Happy trading!

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