I saw the market top coming (and banked 500 pips from it)

What a difference a few days make. Last Friday, the headlines were trumpeting the FTSE having finally breached the ‘magic’ 7,000 mark with bullish predictions for the UK economy – and further gains for stocks.

Then over in the US, the Dow was also knocking on the door of a new high with gurus falling over themselves with bullish predictions for the US economy and forever low interest rates. The sunny uplands were here.

But on Wednesday, the smiles were wiped off bulls’ faces with a decline of 300 points in the Dow – and an even greater percentage fall in the Nasdaq. That is one heck of a switch in sentiment in less than a day.

The bulls have been in total command since March 2009, but now the vastly out-numbered bears are clawing their way back.

Don’t be fooled by by news stories

Was there any earth-shattering news to cause the turn-around this week? There was none that I could see.

There have been mild warnings from prominent economists and commentators that the stockmarket was in danger of getting out of whack with the real world. Also, Fed members have been sounding more hawkish on interest rates (what else is new?). But could anyone who believes that the news drives the markets make a case that the sharp falls were ‘caused’ by these comments?

No doubt the pundits will be falling over themselves ‘explaining’ the turn. But that will be pure rationalisation. My first reaction when I hear post-hoc explanations like this to ask where these pundits were at the market top?

If you’ve been reading these posts for a while, you’ll know how I think about this topic. I say that news follows markets, not the other way around.

According to the ‘news leads the market’ view, the big jump in crude oil – and the fall in stocks – has been put down to the fighting in Yemen. But we have had scare stories emanating from that region for many years – and the bull market hardly noticed.

I, on the other hand, put the big jump in crude oil down to the crude oil market being massively oversold, with few bulls and the shorts being squeezed. The news had nothing to do with the matter.

Fantasy can only persist so long before reality must intrude. I call that the Wile E Coyote moment – and maybe that was reached this week. Markets can turn on a dime.

So today, I want to show you how I spotted a turn in the Dow by focusing on what the market was telling me – and ignoring the news.

How I banked 500 pips

Here is the hourly on Tuesday:

Dow Jones spread betting chart

On Monday, I could draw in my upper tramline which then contained four accurate touch points. Then, I could tentatively draw in my parallel tramline, which took in a few of the lows (this is the centre tramline). With that, I finally drew my lowest tramline, which gratifyingly took in the major spike low of 18 March. That gave me more confidence my tramlines would be valid.

So on Tuesday, I had my tramlines and noted the large momentum divergence at the 18,200 high – and right away suspected a reversal was likely. A break of the centre tramline was to be my signal.

This is the result:

Dow Jones spread betting chart

Yesterday morning, the market broke below the important 11 March low at 17,620 and with a possible momentum divergence forming, I took partial profits – using my split-bet strategy – at the 17,600 area for a very tasty 500 pips profit in two days.

I now have a part position open and looking to re-establish maximum short position on the current wave 4 rally.

Near-term, I am looking for a new low in wave 5 before a decent rally can be mounted. But this morning, the bears are taking over.