All was going well for the markets until afternoon selling soured the entire rally. Yesterday’s big volume and big price move confirmed a new market rally. The unfortunate news today was immediately following a confirmation day was a near distribution day. Distribution so close to a confirmation day spells trouble for the rally 80-90% of the time. We were very cautious on this rally to begin with due to the shape and lack of leadership. Our market model remains in neutral mode, but is leaning towards a sell signal. This rally is on very fragile ground and one should proceed with extreme caution.
A distribution day is not always a bad thing as you will see them from time to time in a bull market. When distribution piles up in a short period of time is a big warning sign. However, when you see a distribution day immediately after a follow-through day is nearly a death blow. If on Day 1 or 2 after a follow-through day there is a distribution day the odds of the rally succeeding is less than one percent. Odds improve if a distribution day occurs on day 3 or 4 to 80%. Odds favor this rally failing and it is precisely why we are very cautious of this market.
We do have shorts now appearing and given the current market environment are now attractive. Shorting stocks is a very dangerous game and is not for the faint of heart. However, it is interesting to see shorting signals cropping up since we have not seen shorts for quite some time. Whether or not this is foreshadowing a nasty decline is anyone’s best guess. If we do push lower we will be positioned properly to take advantage.
Two very telling outside reversals happened today. The first was with the Russell 2000 today and the second was the VIX. Outside reversals are very telling and typically lead to a change in trend. In this case for the Russell 2000 the short-term rally is now in jeopardy and couple it with the distribution day immediately following yesterday’s follow-through day is a major warning flag. The VIX is the complete opposite. Since hitting 30 last week the VIX has been hammered back into the mid-teens. Today’s reversal is just one signal the rise in the VIX may not be finished.
It is clear the long side of this market still remains shaky at best. It will take more than 5 days to repair the damage from the recent selling. Stay patient and stick with Big Wave Trading.
