"Always have your hook baited, in the pool you least think, there will be a fish." ~ Ovid BC 43-18 AD, Roman Poet

We stated in the last two weeks that our volatility indicators continue to put in new highs which suggested that market volatility would increase significantly. The action for the past few days very clearly illustrates this point; one day the market is up 150 points, the next day its down 200 points and then up again another 150 and so on.

Initially as stated in the last update we were expecting the markets to hold in the 12800-13000 ranges or at worst to test their August 07 lows but when the Dow transports took out their old lows the outlook changed a bit and this week the majority of our indicators have started to descend from the oversold area into the extremely oversold Zones. These indicators have several ranges, overbought, extremely overbought, oversold, extremely oversold, incredibly oversold (very rare occurrence) and neutral. What normally happens is that they descend from overbought into oversold then bounce up and pull back to the oversold ranges; in doing so they form what we call a base and this base if established for several weeks or a few months normally holds 90% of the time. When this happens we start to issue higher risk call option plays as we did several times after the Aug 07; the majority of which were highly successful. However if these indicators dip below their previous lows and this is what they have now done it suggests that the markets also need to move from an oversold to an extremely oversold condition. When we couple this with the fact that the Dow transports took out their yearly lows it adds further fuel to this argument that the Dow will follow suite. However the fact that the Utilities went on to put in new highs towards the end of last year suggest that at the very least the transports and Industrials are going to mount another rally. The utilities always lead the way; for the record we are not referencing the "Dow theory" but are speaking of a pattern we discovered several years ago. This is one several reasons we refused to turn bearish despite the severe correction the markets have mounted.

We also decided to examine the action of the dumbest of the dumb money, the odd lotters; these are individuals that short or go long odd lot of shares. Once our indicators move below their oversold zones and into the extremely oversold ranges we need to see a huge increase in short selling by these chaps or a major positive divergence or buy signal from one of our master indicators. While these chaps are shorting the markets they are not doing so in an extremely aggressive manner and they now need to as a result of our indicators dipping into the extremely oversold ranges. When the dumbest of the dumb starts to panic it signifies that the markets have hit an extreme inflection point and due to these new developments we need to now witness an extreme event. Like anyone else we would have preferred if the markets had held the 12800-13000 ranges but they did not and our indicators responded in kind. We have always stated that one cannot tell the markets what to do; one can only attempt to anticipate what they might do based on what they are doing. Those that try to do anything else usually end up losing their mind over the long stretch. Hence we now have to face up to the prospect that the markets are going to have to enter an extremely oversold stage. It would be a lovely silver lining if our smart money indicator were to flash either a strong buy or strong positive divergence signal after the markets enter into the extremely oversold ranges. This indicator has been stubborn and has simply refused to issue a buy signal for almost 2 ½ years. If this were to happen it would be the single most bullish event that could occur and we would start to load the truck up on call options. In terms of intensity a buy signal from this indicator alone is the equivalent of a buy from at least 4 of other indicators.

So let's look at the state of things and while doing so remember that every disaster brings about opportunity and the only way to see this is to be objective and not emotional about what's going on around oneself. In addition one must understand that a disaster or crisis type situation is all relative. Take for example the housing bust; those that bought their homes 2 decades ago are not really feeling that much. However those that purchased in 2004 and 2005 relatively close to the top and with adjustable rate mortgages feel like they have been burned alive. In addition the same applies to the markets if you bought right at the top then you are going to feel pain but if you bought around the last major correction you still in good shape.

The Dow transports hit the upper limits of the extremely oversold zone which falls roughly around the 4150 mark (they recently tested this level); the lower limits fall in the 3650-3800 ranges. Note that it's not a necessity that they test the lower limits; as of now the Dow transports have already tested the upper limits and in doing so they flashed a positive divergence signal. The transports have actually gone on to put in a new 27 month low and since the transports lead the industrials normally, this suggested that the Dow should follow suite and that's exactly what it ended up doing.

The upper limit of the extremely oversold range for the Dow is the 12000-12240 ranges and the lower limit is 11650-11810. This current change in action also suggests that the next leg up in the markets is going to be selective and not all sectors will benefit. It's interesting to note that even though the Dow went on to put new lows the transports did not respond in kind and were able to hold above their January lows; perhaps this could be an early sign of a divergence.

Certain sectors are already showing rather strong signs of early strength and these chaps will be the next leaders when the markets start to trend upward again. One such sector is the Silver sector. One of the reasons we are so bullish is that Gold has taken out its old long term highs but Silver is a huge way from taking these out (old highs roughly are around the 50 dollar mark); if one takes inflation into consideration silver is being almost given away for free at current prices. We have done very well on our Silver bullion purchases and from our original entry point we are up roughly 270% and from our new entry point of 11 dollars we are already up 47.2%. We feel that there is a lot more upside potential while Gold could trade as high as 1500 and then overshoot up to 3000 due to maniac buying, these gains pale in comparison to the potential gains silver could yield. As always do not rush out and load up the boat, all investments should be done in stages and with a clear mindset. Emotions are good for absolutely nothing when it comes to investing.

So let's sum all our thoughts up.

The Dow transports put in new yearly lows and this meant that the Dow industrials would follow suite and follow they did. The taking out of the previous lows pushed our indicators from the bases they were forming in the oversold ranges into the extremely oversold ranges. When this happens the markets usually follow suite. As a result of this occurring we need to see an extreme development and two examples of such extreme development would be a huge spike in the number of shares shorted by odd lotters, an outright buy signal and or a positive divergence signal from our smart money indicator. Another potential development would be to see the overall volume of shares traded spike several times past the 5 billion mark on down days.

In terms of extremely oversold ranges we have upper limits and lower limits:

Upper limits for the transports are 4150 lower limits are in the 3650-3800 ranges;

Upper limits for the Dow are 12000-12240 Lower limits are 11650-11810.

In both cases we have extreme lower limits but this is a very rare occurrence so we will not examine these ranges now.

We also checked the Public/NYSE specialist short sales ratio and this number has spiked incredibly in the last few weeks. From trading roughly in the 8-9 ranges it spiked to 18.20 in August (look how strong the markets rallied after this new high was put) before settling down last week to 14.60. The higher the number the more bullish it is for it means that public is more bearish relative to the Specialists. We note that the short interest ratio on the NYSE for the last 6 weeks has been putting one high after another. All this data sounds confusing for it gives out contradictory info. However we feel that the smart money must know something that the masses don't know and it's for this reason they are holding out and not shorting the markets aggressively.

Conclusion

While we would have all preferred that the Dow held at least above its August 07 intraday lows one cannot sit and mop around and one cannot sit and dwell on the old picture for to do so would be foolhardy. We have to always adapt for the markets have their own minds and a new battle plan has to be thought up. As of now we are waiting for one of three extreme developments we mentioned above to transpire as it will provide an indication that a bottom is ready to take hold.

In the mean time we have noted that our coal stocks have been unusually resilient during this down and are holding up very well and these chaps should go ballistic when the markets stabilise.

New comments 2/1/08

Last Wednesday (23rd January) the Dow went through a remarkable day, from low to high it moved 632 points and the volume blasted all known records. Total volume traded exceeded the 7 billion mark and this to us was an extremely bullish development. Traders world wide panicked and flung the baby out with the dirty water; the herd mentality took over and everyone stampeded towards the exit which just so happened to be a very steep ledge. We advised subscribers to go long in the 11670-11760 via call options on the Dow, QQQ's, SPX etc; those that followed this advice are sitting on huge gains.

Several other interesting developments have also occurred since this article was first written. The Public/NYSE short sales ratio has put in yet another high and we view this very bullish development. Once again the fact that the Indices closed up on the strongest volume ever was a very bullish development. As the indices have broken their intermediate main uptrend lines the going is not going to be all easy now. Volatility is still going to be very high and just as we have several days where the Dow races up 300 or more points we are also going to have down days where it could pull back 300 plus points. In the short term it's going to be 2 steps forward and 1 ½ steps backward; this situation could change in a heart beat to 2 steps forward and 1 step backward or even less. Look how fast we have raced from a low of 11634 to today's close of 12743 for a total gain of over 1000 points in less than 2 weeks. Negativity in the end never pays off; all disasters are nothing but hidden opportunities waiting to be discovered; the key is to be cool and level headed so that you can spot them.

Major portions of this article were extracted from the Mid Jan 2008 Market Update.

"Wherever there is danger, there lurks opportunity; whenever there is opportunity, there lurks danger. The two are inseparable. They go together." ~ Earl Nightingale 1921-1989, American Radio Announcer, Author, Motivator, Speaker