Market Trend Spotting and it’s elements

A friend recently asked me: Do you still think market will head down in big way or it has more less stablised around this level ?

And here were my thoughts: Based on recent over-bought levels, It has to head down, big way or slowly, can’t say Even if it seems to have stabilized for now.
I am still wary to go long. as it’s still as over-bought as it was in mid-April. I am rather short starting last few weeks so I am staying hedged.

Within a day the answer was coming to its roots, and
I hope he was getting the context of my answer, by watching the markets in following days. My answer would not have made sense right then or during last week or 2 weeks back, as sentiment (common man level) was still very good.

Some might question that just 2 days going down is data not trend yet. But I think it was not safe to get in, till that correction happens
I think the correction started this week.. and showing it’s true colors this+next+next2~3 weeks.

It may still show some +ve momentum for a couple of days more, but till the correction (from the big 9-weeks in Mar~Apr hope-rally) completes, it’s not safe to get back in the the world of mid-term “momentum trading” and “market direction trading”. (Ofcourse, in buy-and-hold approach, none of this applies).

And these are my thoughts, not any thoeries that I had read anywhere, so they have their own immaturity and naivete to them.

These days the feeling is worst is over or very close to bottom
But that’s the common man feeling based on what media is comfortable pushing at us. The reality is far deeper and needs much more study, which we don’t do
And we’ll see all this unfold truly by year-end. For now sentiment is depending on what government and financial community wants they can push to common man. And common man is buying based on recent spike which was primarily bounce from over-sold conditions short-covering and then profit-making momentum from recent TARP money through hedge-fund actions.

Having said that, I should add that with our current approach to look at sentiment indicators to predict trend reversals, I don’t think we can even catch day-to-day or even week level trend.. but we try to catch the next one~two month trend or even next 6~12 months trend, assuming no underlying assumption changes.Bcoz if underlying assumption changes, then no trend catching works.

Further, One thing that should be applied besides ’sentiment trend catching’ are the contexts in which markets was operating, like Obamania, Govt reform, bank attitiude, etc.. to determine the strength and probability of strength of any trend.  Currently I use day-to-day and weekly level charts and financial numbers to decide on these trend spotting.  I never trust news to judge for good reasons, as it’s a trailing indicator and that it’s manipulated.

I am yet to learn putting in the context of sentiment into it, which would be interesting to do, provided I had time and priority on that. So with whatever limited I know, all this doesn’t work beyond 6~12 months, bcoz in long-run financial-fundamentals and underlying business sentiment drives market direction. Sentiment saturation indicators work only to catch short-term sentiment reversals.

I must admit, that my short term returns are good.. but long term returns are average..

Thus to have better long-term returns, the market-context, sentiment-context part and “big-economic-picture” part becomes very important. Markets are sticky as it takes time to make everyone convinced that things are over-bought or over-sold. Financial community 1st plays the markets to their advantage and then uses media to influence fear and hope and that’s what “common man feeling” becomes to be. All this recent sentiment facade of “all if good and getting better” created by govt. and financial community, is being used to distribute stocks after biug gains to common man accounts (401k, trading, IRA, LongTerm buying opportunity, etc.)
The feeling in smart-money, which matters more is much more imp. to catch the waves early.

The most rich and savvy market timers I have come know, are saying (not sure how true) are sitting outside since April-end. “Understanding which they direction they want the market to go” is also interesting part of “Context”.

So in summary, we need to start adding weight of the following elements To our current approach for market trend detection.
- “market context”, govt policy, financial community, money-flow,
- And resulting “sentiment context”,
- “big-picture investing”
- “financial fundamental shifts”
- “direction momentum”,
- “markets are sticky” behaviour,
- “pause” between ‘trend reversals’ (due to ‘time required by big/smart-money for gradual-distribution-to-common public after-capturing-gains from previous trends’)

A close watch on Jan~Feb correction and then March~April rally and its imminent reversal in May, taught us a lot.

Enjoy the Game.