Contrarian Signals from Two Indicators

The market rallied yesterday due to reports that European dealers have finally finished a crash course on “haircutting” and are ready to work with their first customer. The issue is who will be next. It is quite unlikely that after spending so much time to become proficient in dealing with the intricacies of slashing debt overnight, they will be satisfied with just one customer. I suspect there are others who will be willing to pay the long-term consequences from such an irresponsible act in exchange for few short-term political gains, mainly.

Two technical indicators generated contrarian signals for the medium-term, despite the strong rally. The first indicator is the MEI and its divergence from price as shown on the SPY chart below:

It may be seen from the chart that the MEI(14) has started declining in value, although the RSI(14) is still rising. It is possible that prices will attempt to rally towards the 200-day simple moving average near $127.50 after overcoming resistance at $126 and then drop again towards $120.

The second indication of a medium-term correction came from the p-indicator. For the first time in a while p-indicator results for SPY and QQQ show a negative short-term bias for 3%, 4% and 5% price envelopes as shown on the screenshot below:

The probability of a short-term upward move and of a short-term downward move are the long success rate and the short success rate of the p-indicator, P-long and P-short, respectively, as shown on the screenshot. P-long, for example, is a measure of the probability that a long position initiated at the open of Thursdaym, October 27, 2011, will result in a profit for the corresponding profit target/stop-loss values of 3%/3%, 4%/4%  and 5%/5% . A more useful measure is the difference between the long and short probabilities, P-delta, which is a measure of the bias, or tendency, of the market to move towards the long or short direction. In this case, the bias is negative across the board for all target/stop pairs used except for the pair 5%/5% for QQQ, in which case there is a small positive bias equal to 1.01. The significance S of all probabilities is moderate.

It should be pointed out that the p-indicator calculations change on a daily basis. Thus, the calculations of the probabilities are valid until the close of the next day when the indicator is recalculated. The same applies to all technical analysis indicators, like the RSI and the MEI. Furthermore, probabilities are not related to events themselves but only to their frequency of appearance, in the sense of the low of large numbers. At least this is just one of the many interpretation of probability.

For more p-indicator past results click here. 

Disclosure: Long QQQ puts as of 10/26/2011.

Disclaimer: The author is not a financial advisor and does not recommend the purchase of any security or advise on the suitability of any trade or investment in any timeframe. ETF, stock, futures, forex and options trading and investing involves substantial financial risks and can result in total loss of capital. If investment or other professional advice is required, a licensed professional should be consulted.

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