Stocks are being routed

Yesterday was the 69th anniversary of D-Day – the Allied invasion of Normandy. It was a turning of the tide in the war… and I couldn’t help thinking we are in a similar position in the markets today.

One clue was provided this week when very ‘encouraging’ UK economic data was released. This is how the FTSE reacted:

Spread betting chart

That ‘good’ news was not gratefully received!

Since 22 May the FTSE has declined by around 9% – this is the date I said would be a historic turning point.

Yes, when third waves get going, they are relentless. I mentioned last time that we are in third waves of three degrees – a most powerful set-up.

As for the news, in Thursday’s newspapers, there were reports of the UK services sector “surging” in May, fuelling hopes that the UK’s economic recovery was gathering momentum.

The services index registered 54.9 in May, higher than many in the City expected.

Here is one typical comment from the chief economist at Markit: “The UK economy has moved up a gear with all cylinders now firing”. I have a feeling he will require more than salt and pepper to digest these words

So why did the FTSE collapse?

It’d take some fancy footwork to explain how the news drove this turn in the market!

But some things never change – in the US, there are TV and radio stations devoted entirely to a 24-hour outpouring of financial matters. I know, I appeared on one of them at one time!

The entertainers who run these outlets peddle the myth that it is the news that matters. And there’s never a shortage of that.

No, the FTSE collapsed because the mood has changed (see my previous posts).
Before, with the bull racing ahead, both good and bad news was good. Now, all news is bad! This is what happens when a bull market turns into a bear market.

At major tops, most people are very bullish – that is their bias. And when the market turns, they call the dip a ‘normal technical correction’ to be later retraced.

This last assumption is a trap. Investors have been so used to buying the dips that they cannot conceive that this ‘dip’ might be their last!

Hedge funds burned by the Nikkei

And here is an even more dramatic illustration of the change in mood: The Nikkei in the last few days has collapsed by a staggering 23%. A fortnight ago, most investors and gurus were massively bullish (Abenomics was going to save Japan, remember?). And now, the market has lost almost a quarter of its value.

Here is the latest commitments of trader data on the Nikkei:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
NIKKEI INDEX X JPY 500 Open interest: 93,321
35,129 6,725 2,916 42,709 30,445 80,754 40,086 12,567 53,235
Changes from 21/5/13 (Change in open interest: -2,268)
-2,846 -2,593 1,465 -4,162 -5,915 -5,546 -7,046 3,278 4,778
Percent of open interest for each category of traders
37.6 7.2 3.1 45.8 32.6 86.5 43.0 13.5 57.0
Number of traders in each category (Total traders: 100)
30 12 5 42 26 73 42

The hedge funds (trend-followers) were over 5:1 bullish – an extreme. But note the small specs were a little over 4:1 bearish – they got that one right!

This is the shock and awe of the collapse:

Spread betting chart

That is what happens when major Elliott waves complete their traverse, and a new wave set takes over proceedings.

Most investors are unable to see the transformation in sentiment and still cling to their views as the market sinks. When they finally realise that the game has changed, that is when they begin selling their shares – after reading several gloomy articles, no doubt.

This is herding, of course.

And that is when major lows are formed – when capitulation takes hold.

Incidentally, in the Nikkei chart, there is a large positive momentum divergence on the hourly chart. A bounce is in the works. And there were several good Fibonacci retracements on the way down – why not run your Fib tool over the Nikkei and find the good short entries?

Also, the 23% decline qualifies the Nikkei as in a bear market – a 20% fall is a commonly-accepted line in the sand.

Exciting times ahead for the Dow

But let’s take a look at the Dow, my favourite trading market.

Here is the daily chart updated from Wednesday:

Spread betting chart

The centre tramline is now well and truly broken and the danger zone for the bulls (pink zone) that I showed last time has also given way.

This is a major shock to the system. Yes, I know many had called for a correction – and many of these will expect a snap-back leading to new highs later in the year. We shall see.

But near-term, the Dow is oversold (I have highlighted the low momentum reading by way of evidence). Normally, this would indicate a large retracement is likely.

Yes, that is possible. But this time, I believe the bulls will be disappointed – many of the largest declines in stock market history have started from an oversold reading. The brief rallies have spiked momentum up, but it soon gets pushed back to the floor.

Using the rally from November, a 50% correction (a typical retracement) would put a target in the 14,000 region – a 1,000 pip move.

Later today, the US employment situation report will be released. As ever, the entrails will be picked over and the market will react.

But when a new trend gets the bit between its teeth, nothing can stop it, especially when the market is being driven by third waves of several degrees.

Very exciting times lie ahead.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline tradingAdvanced tramline trading
An introduction to Elliott wave theoryAdvanced trading with Elliott wavesTrading with Fibonacci levelsTrading with ‘momentum’Putting it all together

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