US stocks on a knife edge; crude and Yen too

There have been new compressions at a daily scale in the last 24 hours in some important US stock indices:

We reported in the January 10th edition that the main upmove in US stocks was probably over because of the occurrence of weekly-scale top extensions in some of the main indices. This does not rule out new highs in those indices but it did/does mean that the rally is on an increasingly shaky footing – in fact it had already stalled by mid-December. These new compressions mean that a new move is coming but we cannot tell in which direction – we follow the break. If prices push upwards in the next few days then there will be yet more strength to come and it may be worth trying to buy for a ‘trade’ but don’t be tempted to hold on for long – those weekly-scale top extensions have a shelf life of several months, during which time it will be hard for prices to sustain strength. If prices move down then a more serious drop is likely. We are long of the Nasdaq and will review that position every few hours. It is still possible that the broad market will hold, weaken a bit or continue to range-trade while the Nasdaq keeps going up.

Elsewhere, Crude oil has compressed and so has $/Yen. The same arguments apply to both of these – a new move is likely to start soon but we don’t know which way so we will ‘go with the break’. It is worth pointing out that a feature of compressions is that they act as ‘strange attractors’. When applied to markets, this mathematical term means that a compression will often mark the start of a new trend but the price often re-visits the compressed area before the trend continues in earnest. There is more about this in our userguide and the main consequence is that it is often wise to wait a bit before entering a trade after a compression has formed – the initial break may be too quick to catch and this ‘return to compression’ aspect of market behaviour can offer a second chance.

Lastly, there has been a top extension in live cattle. We would now watch this carefully, looking for signs of a ‘top’ and sell short if such signs develop. Sometimes we simply sell as soon as a top extension signal occurs (as we did in the case of gold a few days ago – see the January 18th edition) but more often we wait for the price to ‘trace out’ a top. Markets stop rising and start falling quite differently from the way they stop falling and start rising and this caution reflects that. Tops form as a process, bottoms can more often be single events.