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Sell-Offs & Super Spikes.

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Sell-Offs & Super Spikes

Saturday, 7 January 2012 – Melbourne, Australia
By Murray Dawes

Sell-Offs & Super Spikes

Kris asked me to write a quick note to you about my predictions for the stock market for next year. That’s a problem. Because as a trader, my job is to focus on the forces in the market that are affecting the price right now.

I look to take advantage of my understanding of those forces to find good risk/reward opportunities for entering stocks.

In fact, my ability to predict where the stock market will be in a years’ time is next to zero when using charts. That means anything I told you about the future direction of the market would be meaningless twaddle… that wouldn’t be worth the paper it’s written on (even though it’s not written on paper!).

So, if Kris doesn’t mind, I’d prefer to discuss where the pressure points are in the market, and the impact it will have on investors and traders. But first I’ll cover my long term macro-economic view…

You’d have to be living under a log not to know there are some serious headwinds facing the world economy right now. Europe is in recession. America is plodding along at very slow speed, in danger of being sucked back into the “debt vortex” by Europe. And China is fast losing steam on the back of a weak Europe and a slow America.

The European debt monster is slowly consuming all in its path and the central bankers and politicians are throwing as much of our money at the problem as possible. Money printing can never be far away under these circumstances. Next year will be a story of to-ing and fro-ing. On side will be the forces of deflation. And on the other, central banks printing money to avoid it.

Great Opportunities for Traders

Therefore the road forward for stocks will be gut-wrenching sell-offs followed by super spikes on the back of money printing. But each episode of money printing will have less effect on the market than the previous one. The outcome from money printing will be higher commodity and food prices… and little else.

This scenario involves periods of very high volatility that will provide great opportunities for traders who are nimble. But for buy-and-hold investors, this scenario won’t look good for the next year. If you’re an investor (not a trader) looking to time the market I’d say that the first half of next year is a no-go zone until you get confirmation of the next round of money printing from Bernanke.

Even then I would only hold for three to six months at most while the market rallies under the false hope that money printing solves everything.
ASX 200 daily chart

Technically the ASX 200 is currently oscillating around a very important low. Decision time on which way the market will break is fast approaching.

Have a look at the thick blue lines in the chart. They outline the long sideways distribution that our market has been tracing out for the last two years. What is very interesting about the way prices behave is that when it’s obvious to market players that a price level is technically important, a distribution often forms around that price level.

This leads to the “whipping out” of the inexperienced traders who thought they could trade the market around that important level.

Have another look at the chart. The low of the long-term distribution is very close to the point of control (POC 2) of a smaller distribution.

This smaller distribution has formed over the past three months. The way the market breaks out of this distribution is very important.

If the index falls through this smaller distribution, that will confirm the failure of the large two-year distribution. And if that happens, this will lead to huge selling pressure. Think of it like dominoes…
The Unknown Could Send Stocks 30% Lower

The very short-term failure will set off a chain reaction that could see two years of buying looking for an exit at the same time. This is when the market could fall many hundreds of points back to the lows in 2008-09.

Therefore watching the evolution of this smaller distribution is very important.

As I write, the market is selling off below the smaller point of control near 4200 [Ed note: Murray wrote this article on 15 December, 2011 when the S&P/ASX 200 was trading at 4,137]. When the market sells off below its point of control that’s when the momentum shift occurs. People who are “long and wrong” (buyers who bought at high prices) from the top half of the distribution will start to dump positions, giving the bears the upper hand to begin selling aggressively.

The market could fall sharply and quickly to the bottom of the distribution once this occurs.

Therefore I would get out of the way of the market for the immediate future. The current set up points to a retest of 3800-3900. If that level gives way then that is where you will see the long-term liquidation of the positions I was talking about.

After that, who knows where it could fall? The market could even retest 3,100 points next year - 30% below today’s level.

Of course, the big unknown is central bank money printing. This has the potential to throw a spanner in the works. So you’ll have to keep on your toes.

Murray Dawes
Slipstream Trader

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