Change in bearish sentiment in the air? Perma-bears starting to give up the ghost? The signs are everywhere. From this blog to the few remainind bear blogs, the bears are giving it up. Lot fewer "top callers" out there and I suspect the few that continue to call tops either do not trade  or have  little "skin" in the game. This is one if not THE most magnificient bear market rallys of all time. It continues to be my view that this is a cyclical bull market within a long term secular bear market. I will need to see the popular indexes all eclipse all time highs to change my opinion. Can that happen? Yes, of course, anything is possible but as a probabalistic thinker, this is still of a lower probability. I have often stated that the job of the secular bear market is not to reward bears and punish bulls, it seeks to wipeout both. So far, it is doing a very decent job of getting that done. There is one thing I know with absolute certainty: the higher price climbs through time, the closer we approach that inevitable top,  both in price and time. How does one attempt to identify a top? Here are my views and observations.

Anatomy Of A Bull Market And The  Top: The first thing to consider is that market cycles and economic cycles are two distinctly different cycles and they are rarely in sync. A bear market low is the incubator for the next bull market. At the bear market low, economic news is nearly uniformly bad. As the last exhausted bull finally throws in the towel and sells, more bad economic news no long causes price to fall. Margin buyers are gone, wiped out for the most part and there are no more sellers. Now as economic news continues to worsen, price starts to rise. At first there is widespread disbelief. This disbelief is fueled by a number of factors. Humans are social animals with herd instinct. We like to fit in. To go against "group think" invites exclusion from the group. Due to continuing bad economic news, group think is of the opinion that price will continue to decline. This goes to the heart of Recency Bias which states that what has happened in the most recent past will continue to happen. This is normal, indeed, hard wired and probably has its roots in our specie survival tool set. As price starts its ascent or no longer is falling, some short sellers begin to take profit. This starts to move price  higher. Early trend traders, usually trading in shorter time frames, detect the trend and start to buy. It should be noted that during the first phase of the new bull market, like we witnessed after the March 2009 low, there are numerous pullbacks in price. This is due to the remaining herd mentality selling into rising price as well as weak early bulls taking profits as they, too, do not believe in sustained higher prices. These pulbacks allows more buyers to enter the market.  While this is happening, fundamental analysis becomes more positive, enticing fundamental traders/investors to begin to enter the market on the buy side. A trend has started to be recognized by some in the herd who also start to buy. At this point, opinion is split as to IF rising price is sustainable or not as economic news is also mixed. Continued rising price now becomes a readily recognizable trend and momentum /trend traders continue to buy. Rising prices continue to bring in more buyers as the news drumbeat becomes even more positive and/or is "interpreted" in a positve light. Now the "herd" is almost universally bullish. Market bears now start asking such questions as "is technical analysis dead?" as tried and true techincal indicators and chart patterns more often than not, lead to a failure of the "next technical expectation." The failed head and shoulders formation of early July 2009 is the best example of that. There is a saying "out of failed moves come rapid and sharp moves in the opposite direction." The rally into late September of 2009 off the failed formation did NOT allow pullback buying bulls into the market as there was NO pullback. This marked the second phase of this cyclical bull market. Price then consolidates such a large rapid move in basically a sidways or "channeling" market. The channel normally has an upward bias, however. This marked the third phase. The fourth and final phase is now what I believe we have just entered possibly as early as September of 2010. The final phase of the cyclical bull can be marked by a number of observations. Remaining bears continue to short into rising buying pressure and exit more swiftly (adding to buying pressure) with losses. Some, capital depleted, are out of the market. More decide to just sit it out. Overall short interest starts to drop.  Mutual fund cash flows now reverse. Mutual fund money (the dumb money) flows into the market fueling further breakouts to higher recovery highs. Fund money now is much closer to being fully long. Fund managers are the epitomy of herd animals as they chase each other's returns. The concept begins to gain  wide circulation that this cyclical bull is NOT just a cyclical bull but rather a NEW secular bull market and that the all time highs will be soon eclipsed. Throw this into the mix as well: historical seasonal negative influences also seem to be no longer valid.  How does it top? When the last buyer has bought. This can come in two forms. Either a rounding top formation showing distribution or a "blow off" top. I favor the second scenario as to what we most probably will see. This is a very sharp spike upwards. The last of the shorts cover (no more captive buyers) and the very last of the dumbest of the dumb money comes in not wishing to "miss the move to infinity." What you will see at this point is that more positive news no longer propels the market higher. In fact, price may start to "retrace" on good news. The secular bear market now re-asserts itself as price starts to plunge.

As NOBODY knows what happens next, I have no time frame for when this occurs or from what price level the market puts in its top. Tops, like bottoms are a process. They are events only in hindsight. I have attempted to give you some guide posts to that event. As an additional observation, one that could be huge, the very nature of the markets we trade have changed. Analogues to past bear market rallies can fail for the following reasons. Recent changes are the replacement of fractional price with priced in pennies. The advent of the electronic market place changed markets as well. Now, add to the witch's brew the following: the massive intervention in the markets by the central banks and governments, the advent of dark pool trading (beware those of you looking for price/volume divergences!) and HFT (high frequency trading by machines). But the largest change could be the fact that approximately 75% of all trading is now institutional trading. The retail trader has an ever shrinking portion of market impact.

This is all well and good but how is this information actionable? That will depend, as always, on the time frame you choose to trade.

Day Traders: a day trader should have no directional bias when trading. Most important is to try to discover what kind of day it will be as soon as possible as therein lies a very large edge. There are five different types of days. 1) Nontrend day. The market shows little or no extension in price beyond the first hour's range. 2)  Normal day. Shows a directional bias of about 50% of the first hour's range. 3) Normal variation day. The range is expanded by around twice the opening first hour range. 4) Trend day. Price moves dramatically out of the day's opening range and closes close to the extreme direction of the move and 5) Neutral day. Price extends in both directions from the opening range but nets out little to no price change at close. Tip: Trend days normally are around 1 out of 8 trading days. As market get closer to tops/bottoms, trend days become more frequent. Tactics and setups will shift according to what type of day you are trading.

Swing Traders: your swing trades should be in alignment with the intermediate trend. Do not attempt to pick tops in your swing trades. You are trading against the trend and immediately have one strike against your trade. As an example, I sell option credit spreads. I prefer broad market ETF's and broad market futures options when doing this. Each time I have attempted to counter trend trade these (selling bear call credit spreads) by being "cute" and "thinking" a very short term top is in, trade result has been less than stellar. Here is another tip: On page B2 of IBD (Investor's Business Daily) for the NASDAQ and the S&P 500, there are charts. In that chart (close to the top) is a letter grade. A through E. This is accumulation/Distribution. A-B is accumulation. C is neutral and D-E is distribution. When the letter grade changes, through time, two full letters, might want to reassess your market stance.

Position Traders: I am of the firm opinion that position trades, held for long periods of time, should be based strictly on fundamentals. Technicals can and should be used for entry and exits only. Make certain your trade size in this type of trade is in alignment with your risk tolerance and business plan for such risk. Over time, price can fluctuate radically, often not in the direction of your trade. The last thing you would like to see is getting stopped out of a long term trade only to see your long term fundamental assessment later confirmed by price.

I hope this is of some help and benefit.

Yours in the never ending search for the trading edge-Market Sniper