Taking the contrarian approach

You can see in my last posts, here and here, that I was expecting a bearish stock market. However, recent sentiment indicators are telling me to be cautious about this decline. I present this alternate bullish picture at this critical juncture for the market. I am watching the 810-850 region for a possible reversal.

There are several interesting things about this chart. First, notice that it can be interpreted as 5-waves down, which should be followed by 3-waves up. It seems that we've had one wave up, followed recently by a slow correction. In fact, the top of Wave-A has formed a clear "head-and-shoulders", but I think that because everyone is watching this pattern (every blogger I check, even CNBC!), it will not work out as expected. Finally, we've had about 4 weeks of downside action, but volume has contracted more than it was during the uptrend. These are bullish signs.

An interesting divergence is forming in the Adv-Dec volume chart. Notice that so far, the 5- and 10-dma have not posted new trend lows, even though the market has broken through 880 to make a lower trend low. If the market can hold the 810-850 zone, and this divergence remains, I think we could see the market retest 960, and possibly go as high as 1050.

Finally, it is fascinating to see how all the bulls have been extinguished. It is hard to find a blog that proposes the possibility of a rally to new highs. Everyone seems convinced that the head-and-shoulders pattern will commence a new downtrend. With this in mind, I will exercise caution if the market drops further and scale out some short positions.