Are Baby Bulls Base Building?
January 26th, 2009 by Leonard
Are Baby Bulls Base Building?
What is Base Building? It is a period of time when downward momentum in a market slows to a temporary halt and begins to move sideways. This happens when the realization of much of the “known” bad news has been discounted in the market. It is a price area or price range where some traders are willing to take the risk of buying what they believe to be the construction of a developmental platform from which a bull market will emerge into the future.
First, A Little History
On Nov 19 of 2007, I outlined and published the projected downward path of the bear market that unfolded in my Training for Traders Blog. That path not only included the important price points that would be touched many months into the future, but the time at which those price points would most likely be reached.
All of the price objectives were met including the recent Nov 21, 2008 technical bottom that completed the approximate minimum price objective of the complex Head and Shoulders Top. As predicted in my last newsletter, the Nov 21 technical bottom is now being tested. This is quite normal activity.
Surprised to the Upside
The market bounced hard to the upside after hitting its technical bottom on Nov 21, 2008 and continued rallying for 5 days. Markets do this when short traders, not knowing that a major technical target has been achieved, are taken by surprise by an important reversal. Buyers wanting to get out of their short positions try to do the correct thing. They wait for a dip to exit their short positions, but in this kind of situation, dips never come and the force of their panic buying pushes other short traders out of position.
Just before the bounce, some traders had already been skittish about oversold conditions as Citibank and JP Morgan had been beaten down throughout the previous week. There were also several Obama cabinet appointments including that of Timothy Geithner as Treasury Secretary that the traders saw as re assuring
Most traders missed their chance to catch any of the 5 day rally.
Buyers run out of Steam, the Market backs off
As the initial 5 day pushed upwards it ran into overhanging supply, the rally subsided. More bearish news came forth and the mood ring turned the market back down. This too is very normal activity.
As the market comes down it probes for more demand from new buyers who missed the first rally and from shorts that have changed their mind about being short.
Base building is a process where the market bounces around in a trading range. It is trapped between over hanging supply of those who want to liquidate their holdings (fear), and underlying support of those who want to buy what they believe to be discounted prices (greed).
Time to Enlist Sherlock Holmes for Clues
There’s a new game afoot Sherlock. Let’s take a look at some of the detail on the charts of the E mini S&P to see if the baby bulls are base building. To do this we need to move down to the hourly charts for the inner construction
Studying Gap Clues on the Hourly Chart
You are seeing common gaps (pattern gaps), that have been left uncovered (open gaps) higher up on the chart. Gaps are created when news items force the market to open higher or lower than the previous day’s range. These gap areas become natural resistance areas when they are above the current market action and natural support areas when they are below the current market action.
Traders expect that when the market reaches a gap that it will act the same way as when the gap was created. Therefore it is anticipated that if the market reaches the gap above at 856 or 920 that sellers will be waiting to drive the market back down. That doesn’t always happen.
Studying the market action at gaps gives us an indication as to the strength or weakness of resistance and support. There was an open gap at the price of 802 where buyers were waiting when the market had recently come down. The market promptly lifted up from that price level and neutralized some of the bearishness.
Bring out the Microscope Sherlock
Let’s take an even closer look at the game board to see if there are any mood changes developing. This is a close up view of the Hourly chart from about Jan 6 through Jan 26.
Notice that from Jan 6 through Jan 14, the market came down in a distribution pattern commonly called stair step distribution. The market flow is down then level, then down then level, then down etc off, with no real rallies as the bears relentlessly pound the market.
Notice that since Jan 15 the buyers are scooping up contracts even though the market is still coming down. In other words there are at least some significant rallies taking place even though the fundamental news is as bearish as ever. These are buyers who believe that some bearish news is lagging and old and already built into the pricing structure as a discount.
When baby bulls are buying dips it is called accumulation. Thus we see the struggle between baby bulls and mature bears. Every time the baby bulls are able to push the market higher over recent peaks of distribution on a closing basis, they wrestle some control away from the grip of the bears. That process is taking place right now but it is a tenuous and nervous situation.
Day traders either love or hate these kinds of markets. The ones who love it are very flexible and light on their feet. It is a typical area where positions are being established by long term position traders who want to nibble at a bottom (baby bulls).
What do the Bulls Need
The baby bulls need stabilization. For example, any bearish report on housing that is less worse than the previous worse report would be taken as a sign of stabilization.
From a technical standpoint, the blue line on the hourly chart represents the 50 bar moving average. It is a mainstay moving average for the stock market. In order for the bulls to advance prices they need to push the market through that moving average as they have and continue to sustain prices above it. Then at some point the same would need to be done on a daily chart.
This wouldn’t mean that a major bottom is in. It would mean that for the moment, bullish traders may be able to gain control of the market action and bring the market to higher levels where sellers will be waiting in the wings such as in the overhead gaps at 856 and 920.
Further On Out
If the market should manage to work itself up to the 920 level then of course the baby bulls will be looking for more baby bulls to sustain the up move. We will probably see the CNBC pundits getting excited about the upside and proclaiming that the test of the Nov 21, 2008 has been confirmed.
However the market will then be nearer to the high end of the 3 month old trading range. Follow through to the upside would depend on how well the bulls can eat into the overhanging supply of stock that traders want to liquidate, and whether confidence is building in the stimulus program that will be passed.
Failed Accumulation
If the market fails to sustain prices above the 50 bar MA on the hourly chart then there could be more immediate spilling to the downside. To further test the Nov 21 lows.
Ying and Yang
When I look at the fundamentals of the economy 6 months, 1 year and 2 years out I see 3 forces of motion.
One. Nothing will stop the deflation of assets. Those assets will eventually be smoldering ruins.
Two. The Feds and the Treasury have been trying to slow down the speed at which assets and the economies of the world are deflating; their actions are temporary brake pedals.
Three A stimulus package will be launched in an attempt to rebuild the economic infrastructure. Along with that…new rules, new regulations, accountability and transparency. At least that is the hope.
Will there be a Capitulation? It’s Very Possible.
Technically we have not seen a major capitulation to the downside. We have not seen that wash out that says that the bulls are in complete panic. Most of Wall Street has Thain on the brain.
My cautious side says let’s go at this one day at a time and watch the market flow as compared to the news. Nihilistic bubble heads and pundits are still around. They just don’t have as many toys to play with. If history gives us any lessons then we should know that real change often comes with real pain.
Lastly it may not be “all about us” and “our economy”. A capitulatory down leg wash out could come from out of the blue through an international crisis, jolting the fear meter to new levels of crazy. Baby bulls may be base jumping at that point.
Maybe Yoga’s the answer.
Maybe it is Ying and Yang, the perpetual circle of life?
On Wednesday January 28, at 4:30 EST I will be conducting a one hour seminar about various Novy Principles of Market Flow. You can register at this link.
http://www.onlinetradercentral.com/presenter_090128B.asp
The seminar is free and on-line.
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