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Bulls And The Contrarian Play

10/18/11 11:34:50 AM
by Billy Williams

Pessimism is rising as investors sour on the current market, but that extreme pessimism coupled with key technical factors may signal a bullish trend.

Security:   GOOG, AAPL
Position:   Buy

Ever since the Standard & Poor's 500 (SPX) tested the August price lows at the beginning of October, investors have become incredibly sour on the market and grown more pessimistic about its future. To be sure, the market's prospects don't look that favorable, as Europe teeters on the edge of a financial abyss.

What should be of interest is that since those lows were tested, a bounce has occurred that has become a rally. It appears to have turned into a price reversal, as support has held off those lows and the SPX has broken its intermediate-term trendline, indicating that price has become bullish again.

FIGURE 1: GOOGLE. Google's price action meandered but recently exploded upward above the 200-day simple moving average (SMA), a key indicator that can also act as resistance but in this case was invalidated as Google's price moved into bullish territory.
Graphic provided by:
More curious is that record levels of pessimism on the part of investors has continued to either rise or at least hold despite the reversal to a intermediate bullish trend. According the October 12th release of the Investors Intelligence survey, those polled who say they are bearish on the market is at 46.3%, while the number of bulls is 34.4%.

With more bears than bulls in the market, the contrarian view looks at it as a good sign. Crowds are often wrong and given to extremism and in the market, this phenomenon is played out over and over again. As a result, it is best to be more bullish on the market than most when everyone else is negative.

For example, when the market topped out several months ago, there was a huge number of bulls and very few bears and the sentiment at the time reflected little to no worry that a crash was possible, much less imminent.

FIGURE 2: AAPL. Apple Inc. has had a lot to contend with -- a bad general market and the passing of its visionary founder, Steve Jobs -- yet its price marches upward as bulls begin to reveal that they are making a play to take control of the market's trend once again.
Graphic provided by:
Today, even more interesting is that surveys show a rise in the number of bears and a big drop in the number of bulls from the prior week. Again, present-day contrarian perspective is that the rally has legs and will continue.

Already, stock leaders like Google (Figure 1) and Apple Inc. (Figure 2) are making a show of force in their price action, as it is showing that the bulls are making a play at getting control back from the bears, forcing the market higher.

Google, in particular, is revealing a lot of pent-up potential to the upside as it has exploded higher for no apparent reason other than the bulls are entering the market again.

A work of caution is in order as you note that the trade volume on the SPX is low and somewhat stagnant. This can be due to caution on the side of the bulls, but once they enter the market with conviction, you can look for price to make strong surges to the upside.

Stick with stocks that have proven strength in the market during the recent downturn and for price patterns that lend themselves to a upward bias on stocks that are heavily followed. As the bulls gather strength, be prepared to enter the market and ride the wave of momentum to the upside again.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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