Wednesday, March 31, 2010

Don't Be Surprised When the Market Tanks

We're Headed Toward Another Bolshevik Revolution

By Jeff Clark March 30, 2010

In the world of technical analysis, price action is king. I'm bearish. Everything in my heart, my soul, and my mind tells me I have to be short the stock market. But I've avoided making large downside bets because the price action – the king – has been so persistently positive.The peasants, however, are not very enamored of his royal highness. Volume is weak. Negative divergences exist on nearly every momentum indicator. Sentiment indicators show remarkable investor complacency. And the world news is highly negative. Yet, the king continues to reign. But here's the thing...When kingdoms are overthrown, it happens overnight. It's an instantaneous transition of power. One day, the king is in charge, the next day it's a religious zealot, a military general, or a drug kingpin. It always comes off as a surprise. But in hindsight, there are always plenty of warning signs.Think back to the Bolshevik Revolution. The Russian royal family was slaughtered overnight, but the peasants were unruly for months beforehand.The CIA was aware of turbulence in the Middle East long before the Shah of Iran was exiled in 1979.The Berlin Wall collapsed overnight. But the blueprints for its destruction were drawn out months ahead of time.In hindsight, all of these events were predictable and foreseeable.The same is true of the stock market crash in 1987... Economic conditions were faltering. Interest rates were rising. The public's appetite for risk was growing. And stocks were rallying on the back of deteriorating technical conditions.Anyone, with even the simplest understanding of market conditions, could have called the crash in 1987. In fact, many of the brightest analysts did. But they were early and their reputations suffered as stocks continued to climb despite the overwhelming technical divergences.I remember 1987 well. I was a young trader, and I was on the wrong side of the market for five months before my bearish bets finally paid off. In August 1987, I was so perplexed by the market's action I considered leaving my trading post and pursuing another career. Heck, standing behind the plexiglas booth at the local gas station and putting $10 on pump number 5 was a more attractive career path than what I was doing at the time.When it finally happened that October, the crash of 1987 took almost everyone by surprise, and it seemed to happen overnight. By now, though, we all know the warning signs were everywhere. So, too, were the warning signs when the Internet craze crashed and burned in 2000.Today isn't any different.I know, I've been bearish for months and I've been wrong – even though I haven't bet heavily in that direction. I'll wear the egg on my face for as long as necessary.Every day, I wake up and I look for reasons to be bullish on the market. There aren't any – except the king remains in power. Meanwhile, the peasants grow more and more restless, and the tension continues to build.

Months from now, we'll all look back at this time – much as we all look back at October 1987 and March 2000 – and we'll remark on how obvious it all was.Yet we'll be surprised that it happened out of nowhere.Best regards and good trading, Jeff Clark

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