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The Bear Trap of the Century.


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#1 Stickan

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Posted 04 September 2006 - 06:04 PM

Some of you oldtimers may feel I am beeing too detailed and explaining too much, but this piece was initially written for a group of Danes and most of them are not too familiar with TA. Please have patience...

Usually in TA we look for price to do what it is “supposed” to do. We analyze and say, according to my analysis xxxx is going up, this trend line will hold, or price will go down since the neckline broke. If price doesn’t do what it is “supposed” to do, we accept the fact and conclude that we made something wrong.
But, perhaps we didn’t do something wrong, perhaps “the market” changed it’s mind! If that is the case, many players have been caught on the wrong side along with us, when the failure is correcting. Failures can occur in all time frames. This "failure logic", is the “logic” behind the discussion below.

Another point to keep in mind with regard to the overall picture, is a theory William McLaren talked about on his website. There he has shown how price, after an initial phase, price makes a pause, the up movement trails off, before the new trend starts again. This new trend can be 1) a steeper continuation of the trend or 2) a new downtrend.
The problem, is that you don’t know, if we are consolidating for an acceleration up or distributing for a decline. You have to wait for the clue or the break. Let’s look at the Nasdaq index from 1989

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In the chart above we can see how the left up trend developed in 3 phases (in this case accelerated). The 2nd phase ended with a break down failure, which resulted in an up panic. First came a break with abottom on Sep 1st and the second break ended on October 8.
In the next chart below, we can see what happened in 1998, in close up. After the 1st break, we just went up to the 50% classic correction level and closed the gap – the up move has a typical corrective appearance and we never broke the Aug high.

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If we look at the 2006 chart below we can see that we already have had two breaks and that the up move is nothing but corrective.
1.It’s a typical impulse wave with a five wave construction and the 3rd wave being really fast.
2. Two gaps – a break away gap and a run away gap.
3. We have broken the neckline of an inverted H&S pattern
4. Friday we broke the July high.

It looks like we very well could follow the pattern from 1998. Actually it looks even better, since there was no pattern in 1998.



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OK so what’s the big deal about a break and why is it so important.
It relies on the assumption, that the movement from the 2004 top in the chart below has been a two year long distribution phase, which should have started a large decline into the bottom of the four year cycle this year, or a new bear market.
To see the “logic” behind that, just follow the numbers from 0-10 in the chart below. They should explain what happened and what was “supposed” to happen. Please note, that the last break at 9 is also the break down of a 1 yearlong H&S pattern (july2005-July 2006). The H&S is not marked, but the horizontal neckline is there.

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The idea behind the distribution “theory” is simply that every possible, important, support line since March 2005 (no1) has been broken, the tests, from below, has been weaker and weaker (especially no 6 should have gone up to the blue line before declining. Instead it broke down below the green line again It’s what price DIDN’T do that is the clue here)). Furthermore break outs on the upside have lacked follow through and failed. Thus setting up for a large decline into the 4 year cycle low in October, which “everybody” has been expecting. However, after the final break at “9”, the setup for the decline, something happened. The market changed its mind. We are back inside the bearish rising wedge





When we have several trend lines (and vertical cycle lines) passing through one small area. It means one of two things and if it’s not one thing it’s the other (smart huh?).
First look at this chart of the German DAX index


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What we should look at, is the green square in the middle of the chart. That’s where several different important resistance lines meet (2 forks, 50% retracement level, trendline, old tops.) This would be heavy resistance right?
But what happens is that price cuts right through, it’s like there is a tiny hole in all the resistance – like the sweet spot when you are playing golf. That’s one way price can react to a spot like this. The other way is shown below. That’s what we usually see.

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Here we see the other alternative on how price can react.
Since this is not a “sweet spot” it is genuine price support + fib time support (the time is right for T/C).
(the thick blue B line is parallel to A). What we see is long term support of great significance.


Let’s look at SOX from another point of view.

What we see below is a long term inverted H&S, with a breakdown below the neckline (failure). A breakdown, which would cause a severe decline (that's what failed H&S patterns genrally do).
But the breakdown doesn’t follow through! We are, again, back above both trend lines! We might have a “failure of a failure”, which produces even stronger reactions than plain failures do. Also, look at the oscillators below price, long and medium term, they both show bullish springboards. (the upper one even displays a failed kiss of death!).

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In the chart below we are looking at a daily chart of SOX up to last Friday.
It’s interesting in several aspects.
1. It shows how precise TA and trend lines (incl. a 5year long neckline….) sometimes can be.
2. Again we have the choice of “Sweet Spot” or “Solid Support”.
3. It’s also interesting that SOX sank while the other indexes rose that day (was it because we needed the correction before lift off?)
Anyway, the chart should speak for itself – any strength on Tuesday, indicates “Solid Support”


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Let’s look at Nasdaq100 below.
What we should look at here:
1 Failures (blue)
2 Result of Failure (Blue)
3 Gaps (arrows)
2 Bearflag (pink)
3 H&S pattern (red)
5 Volume




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This chart shows what happens when price doesn’t do what it is “supposed to” – when Mr Market changes his mind.
To the left we have a break down failure, which results in a powerful up move with a breakaway gap. To the right (where we now are in time) we see the same thing. Only this time we also have a BEAR flag with a break out on the WRONG (!) side with a breakaway gap and high volume. The follow through is textbook, a test of the the flag and a new high. - And here comes the best part – that B/O is ALSO the break out of an inverted H&S pattern.
This is powerful stuff!!

What about other indexes?
Let’s look at S&P 500.

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We broke above the neckline of the H&S at the end of July. We have tested the neckline and broke above the June 2nd top with a powerful move – were stopped by the 78,6% retracement level (Which Robert Miner many times have said is the final turn-around point if we still should be in a downtrend – hence we are not).
Friday we broke the upper blue trend line.
Check out the volume after the Aug 16 B/O – total disbelief – this is not distribution – it’s a correction.

And talking about volume – check out the OBV in the weekly 8 yearlong chart of S&P 500 below.
Not only is OBV rising when price is declining OBV is also above the 2000 top.
And MACD is setting up a gigantic “springboard” (macd declining while price rise).


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Anything interesting happening in the DOW?

Not really – same as S&P

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Dow is breaking out at the best possible place of the Wedge, close to the apex. But check, again, how the small breakdown failure is setting up a fast up move (Mr Market changed his mind and several people were left behind…).
I don’t think I ever saw such a perfect wedge, price touched trend lines 8! Times before break out on the UPSIDE of a BEARISH wedge, at the same time breaking the 78.6% retracement level!
Can the message be any clearer?
If we stay at this level Tuesday we have a “kiss of life” in the oscillator.


Is this a US phenomenon?

Not really – check out DAX below

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It is a similar picture – two failure breaks of an important trend line – break out on the wrong side of a rising bearish wedge. It is has been tested and we are ready for lift off (check the rising bottom lines). Furthermore we have a “kiss of life” in the long term and medium term oscillator.



Let’s look at Sweden

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This is Xact Bear, which declines 1,5% when the index rises 1% and vv.
We have to H&S patterns (one bullish blue and one bearish red)
This is a beautiful example of a H&S failure (blue), which has resulted in a bearish H&S developing instead. The blue one has now clearly failed and the bearish one has had it’s neckline broken and is forming a new low. Inverted H&S failures promises new lows below the Head (H), meaning a new high in the Swedish stockindex.
And look at the falling blue wedge – seems like we have a breakdown at the worst possible place (best- if you are bullish stocks). The last volume bar is not correct it’s a copy of Fridays volume –which is impressive though. And talking about volume – seems like lots of people started invest in a falling stock market since the beginning of May! Check the volume.
Now they all have to change their mind and BUY stocks.

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And looking at a long term chart, above, of the Danish stock index of the 20 largest stocks (OMX20), one might ask: What bearmarket?

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I find this chart very well explaining what happens when we have a break out failure. Every wedge has a false brak preceeding the real break on the other side.
The question is, will a large break down failure cause a large up move?
We’ll see.

Finally, more as a curiosity, when did the market change it’s mind?
Well, it was on August 15 at 8.30 AM, ET or 2.30PM CET (Central European time )
Look at the picture below.

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It’s a one-second chart of the most important exchanges in Europe.
At precisely 2.30PM, when producer price index was released, Everything went straight up, the “whole world” went bullish.

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Same thing the next day (Aug 16 above) when we got the Consumer price and Housing start figures

Now let’s look at the Nasdaq 100 chart again.

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In July we broke down from what actually is, a Head and Shoulder pattern. The neckline was tested where the blue line crosses the pink line and the market went down, just like it should, for the usual September/October decline. We were still below the green main falling resistance line.
Then Wham! – came the Aug 15 and 16 figures and we were gapping up – breaking both trend line and neck line.
The down trend is history - a gigantic bear trap is a fact. A Trap that was set up with the distribution phase from 2004 and snapped locked on August 15, t 8.30 AM ET.

PS
I just saw dcengr's post with the chart from decisionpoint, which shows the magnitude of this trap. I just added a few lines myself.

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regrds
stig

#2 dcengr

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Posted 04 September 2006 - 06:49 PM

It could very well be that this time, the breakout is real. But one shouldn't just use price patterns to make decisions.

I was short in may despite sentiment and breakout, because underlying internals were deteriorating badly. This time, internals aren't that bad, but there's an ever so slight divergence in NYMO that's developing.

One must always have a reason for why one takes a trade, but if the market disagrees, you need to respect stops and reevaluate.

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Qui custodiet ipsos custodes?

#3 dougie

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Posted 04 September 2006 - 06:58 PM

WOW: what a missive! One thing though: what if the H&S now breaks down? wouldnt the failure of the failure of the failure be even more bearish? <:

#4 Stickan

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Posted 04 September 2006 - 07:07 PM

WOW: what a missive!
One thing though: what if the H&S now breaks down? wouldnt the failure of the failure of the failure be even more bearish? <:


yes

#5 dcengr

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Posted 04 September 2006 - 07:13 PM

WOW: what a missive!
One thing though: what if the H&S now breaks down? wouldnt the failure of the failure of the failure be even more bearish? <:


And if the failure of the failure of the failure fails, would that be even more bullish? :lol:
Qui custodiet ipsos custodes?

#6 raleigh

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Posted 04 September 2006 - 08:46 PM

Very good work Stickan

#7 OEXCHAOS

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Posted 05 September 2006 - 07:50 AM

Nice work, Stig! I remember when you trotted by with a somewhat similar analysis of a "supposedly" bearish rising wedge that happened to break to the upside. That was a nice call. This one is mighty complex, so it'll be very interesting to see how it plays out. For what it's worth, I learned from the last time you felt compelled to show us how things were "supposed to work out". Thanks, Mark
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#8 scott in Wisconsin

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Posted 07 September 2006 - 10:21 PM

Good work, Stig, as always. Do the last 2 days of trading change the view at all? How far would things have to fall for you to rethink? Scott