Is The Market Building A Bottom?

11/19/08 09:06:46 AM

by Matt Blackman

One good overall measure of the market is the Vanguard Total Market ETF. What is it telling us about the market?

Security: VTI
Position: N/A

The Vanguard Total Market exchange traded fund (ETF) (VTI) is a good proxy for US stocks and includes nearly 3,500 US stocks with a market cap of nearly $30 billion (September 30, 2008) compared to 500 stocks for the Standard & Poor's 500 and just 30 in the Dow Jones Industrial Average (DJIA).

The selling climax that occurred during the week of October 10 shows that retail investors (weak hands) were selling but the fact that the price has not dropped below the October 10th lows in subsequent weeks indicates that someone must be buying the lows. A further bullish sign is that prices rose on low to moderate, which indicates a lack of selling.

This was followed by a bearish top reversal pattern during the week of October 24, showing that the pros were again testing the market to see how many "weak hands" they could scare into selling their stock. But again major support held.

FIGURE 1: VTI, WEEKLY. This chart of the ETF shows prior bearish patterns, first a bear pennant and then the bear flag, both of which formed on declining volume. The latest pattern looks to be a bearish descending triangle but note the key difference. Such patterns generally are accompanied by falling volume, but volume has risen sharply during the formation of the triangle pattern. In addition, note that support at $40.50 has been solid. Put it all together and it looks like professional accumulation — pros look to be buying anytime retail investors sell the stock. This is potentially bullish.

Graphic provided by: www.TradeGuider.com.

During the week of October 31, VTI rallied to close near the weekly high on rising volume, which is bullish and shows accumulation. This was followed by another test in which price moved higher but then closed well off the weekly high.

The week of November 17, we see that the price was pushed down below $40.50 support but then immediately bounced back on even higher volume, indicating another shakeout. As long as the professional traders and money managers can scare the weak hands into dumping their shares through violent price swings, they will do so until they have accumulated enough stock. Then and only then will prices begin to rise but will only do so as long as the buying continues. Another caveat is that smart money indicators tend to be short term as we see from Figure 1.

According to Gavin Holmes, trader and CEO of TradeGuider.com, the current high volume on these down bars (weeks) will need to be tested. This can takes weeks or even months and will result in prices appearing to move sideways while this takes place.

"If we continue to test and hold the $40.50 [support] area on VTI, this would be a bullish sign. We then wait for an uptrend to show itself before we rush in and buy, especially when a bear trend is firmly established," Holmes said.

But a break of $40.50 support, especially given the descending triangle pattern forming on rising volume, has ominous implications.

Descending triangle patterns with rising volume are rare; this occurs in only one of five patterns, according to Thomas N. Bulkowski, author of Encyclopedia Of Chart Patterns (John Wiley & Sons). And if we do get a rally, it could be short-lived based on his research.

"Triangles following the market trend — bull market, upward breakout and bear market, downward breakout — do better when volume trends higher throughout the triangle. The countertrend triangles do better with receding volume trends," Bulkowski explained in a November 15th email.

"Since this is a bear market and if the breakout is downward, look for a larger decline than would occur otherwise. If the breakout is upward, expect the rise to be less than it would be in a bull market. The numbers prove that this is how things work — at least for this chart pattern."

In other words, we are still in a bear market and any rally will be countertrend and probably abbreviated. Calls that we are at a bottom are at best extremely premature. This continues to be a trader's market where tight stops and quick reactions are essential — certainly not the kind of market for a buy & hold investment approach.

Links
More on the chart patterns:
o http://thepatternsite.com/dt.html (descending triangles)
o http://thepatternsite.com/voltrend.html (volume trend)

Matt Blackman

Matt Blackman is a full-time technical and financial writer and trader. He produces corporate and financial newsletters, and assists clients in getting published in the mainstream media. He is the host of TradeSystemGuru.com. Matt has earned the Chartered Market Technician (CMT) designation. Find out what stocks and futures Matt is watching on Twitter at www.twitter.com/RatioTrade

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