Nobody Wants to be the Last Solider to Die in War, Things to look for in a Market Top Part 2

"The greatest point of market opportunity is when you feel alone."-James Dalton

"If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you
But make allowance for their doubting too;
If you can wait and not be tired by waiting..."  -Rudyard Kipling


   This is part 2 on my series on what to look for in a market top. In this post I'm really going to dig into the details of what to look for and hopefully you will know when the time is right to fade this market, & also (probably more importantly) when the time is not right.
   First & foremost, you must first realize that markets very very rarely go straight from bull to bear, or bear to bull. The vast majority of the time, we will go from bull, to balance, to bear, or vice a versa. So basically us traders almost always have some amount of time on our side to realize that the paradigm is about to shift, you dont have to try to short the high tick on longer time frames, its just not necessary.  But we have all seen someone the past month desperately trying to justify a failed short in this market. The human mind is hardwired to seek concrete answers. Our tendency is to acknowledge only those answers that support our predisposed beliefs, which can lead to tunnel vision, shortsightedness, & in the end, losing positions. We've all seen someone the past month stuck in a short, "Earrings were terrible for this quarter, unemployment is still way to high, our President is running the country into the ground, the Fed cant print money forever!" and so on & so forth. Humans will use any data point or argument (no matter how vague) to justify whatever our belief is, especially when money is on the line!
   So lets get into the real nuts & bolts of what to look for when a trend is starting to grow tired. As I mentioned in part 1, market structure is key when assessing risk of any position, & the greatest factor in market structure is balance areas & there relationship to each other.
   Clue #1: "The stronger the trend, the greater the distance between successive balance areas. As the auction ages, this distance decreases. In the last stages of the trend, price may continue to rise, but the next balance area will often be resting on top of or within the prior, lower balance area." -JD MIP

As you can see in the above example of AAPL, from Sept 2011 through Jan 2012, she created a nice balance area between approx 363-425. At the start of Feb 2012, AAPL broke out of the balance area & proceeded to trend almost 100 handles straight up. She then balanced again between approx 550 to 626, in Aug 2012 she broke out of balance again, but here was the shot across the bow to the longs, she trended up only 17 points as compared to the previous breakout of 100 points. AAPL continued to balance just above the old balance area, another shot. The final warning was on 10/8 & 10/9 2012 when AAPL dropped back into the previous balance area (circled in white) & accepted price back in the old balance area. This was a drop dead give away that the longer term bullish trend in AAPL had most likely come to an end. Also on a side note, guess what, you didnt have to short 700 to get a great short trade out of AAPL, you could have simply waited for the 3rd & final shot across the bow & got a nice 250 handle short out of it, no guessing or dart throwing involved!
   Clue #2: "Trends that are growing "tired" will begin to exhibit increases volatility w/o producing much further directional progress. Additionally, volume will begin to decrease &, in some cases, auctions that are in the direction of the trend will be accompanied by less volume than on days the market auctions against the trend......Another sign that the upward trend has aged is provided by observing the counter-trend auctions-auctions that, in many cases, were stronger than those that occurred with the trend -JD MIP

So in the above example in GMCR, she had been in a monster uptrend for quite some time, & had continued to double its share prices over & over. The bottom indicator is just the ATR, average true range, & as you can see where I've draw a white line was the day volatility pretty much doubled overnight for GMCR and the ATR stayed up for almost a full two months before the price went from the all time high at 116 all the way down to 17 bucks & change just a year later. This is a really nice example of a product exhibiting increased volatility w/o producing much further directional progress, a key hint that almost always signals a longer term trend is coming to an end. Also if you note again, ya didnt have to catch the high tick to get a great short out of it, it gave traders almost 2 full months of shots across the bow before she finally broke.

This is the same chart of GMCR in the 2 month period of increased volatility when it made its all time high at 117. Notice that 8 of the 10 biggest volume days were DOWN days, while she is hovering just under all time highs, another shot across the bow.
  "There always has to be a scapegoat, so everyone can externalize their angst & anger. After all, it would be too esoteric to blame the market's decline on "weak structure." It cant be said often enough: you must develop a holistic understanding based on the market's real-time structure in order to separate yourself from the pack & become a truly competitive money manager."-JD MIP
Can you image how many traders & money manager made excuses & came up with scapegoats for GMCR going from 116 all the way back down to 17, & every clue they needed was right in front of there eyes, even the market structure was very poor to go along w/ EVERYTHING in clue #2.
   Clue #3: "If the market is attracting new buyers & had any real underlying strength, an upside breakout to new all time highs should exceed the upper end of the volume range. Investors often lament that "No one rings a bell at the top of the market." But in a sense, the low volume that accompanies an upside breakout is that bell." -JD MIP
Same example from GMCR, the day she made the all time high at 115.98, the volume was approx 3.5 million, but the 20 day average for GMCR was just over 3 million! If GMCR's higher prices had really been bringing in more new buyers, (the day should have finished green, vpoc should have been at a new all time high as well) the volume for this day should have been well above 3 million, not just marginally above it.
   Clue #4: Poor structure & poor volume distribution among the daily profiles. This is really kind of a more abstract & dynamic clue that a trend is weak. James Dalton defines poor structure as the following, & I really cant think of a better way: "Market-generated information (MGI) that comprises poor structure are as follows: accumulating poor highs or lows, wide points of control (VPOC's) that are not revisited, accumulating anomalous, or non symmetrical profiles over time, strung out profiles that are asymmetrical in shape showing no healthy elongation, daily bar charts that are strung out & show no balancing-no 'elevator stops' that reflect healthy balancing as a market trends up or down. This is to say that as more suspect MGI develops, the structure is worsening at an increasing rate & factors into our market perspective accordingly." So basically poor highs & lows, ugly looking daily profiles, & moving straight up or down w/ no balancing are the major things were looking for in clue #4. I  could probably do an entire blog post on just clue #4, but I'm already getting long winded so we'll leave that for another day.
   So to recap, days in the direction of the auction time frame you are trading should result in better volume, stronger auctions, progressive VPOC migration in the direction of the trend, balanced profiles followed by elongated profiles, not added volatility w/o continuing in the direction of the trend, not overlapping balance ranges, & not bigger volume on counter trend rotations if your looking for a trend to stay in tact. Or to put it simply, for an uptrend like we are in now, you want to see higher prices bringing in MORE buyers w/ good structure, which is all I've seen for quite some time. But stay nimble my bullish friends, someone ALWAYS has to be the last man to die in war.......
 
P.S. Again almost every quote was taken from James Daltons "Markets in Profile", its a great read & I highly recommend it even if your not a market profile trader.