Friday's Trend Test a Success

On Friday the major indices survived the trend tests we outlined last week and we saw sectors bounce pretty much across the board. Most importantly, the SMH (Semiconductor Holders) saw buyers step in at its long term trend and the closing price left a strong high volume buying signal in the sector. Since this sector has been the anchor around the neck of the NASDAQ recently, a rally there should let tech take off. We should note however that we do not expect a sharp move off of support levels just yet. The bond market is still trying to find a bottom and as long as bonds continue to lack stability, the trading range in stocks is likely to continue. There is evidence that smart money is using this stock trading range to accumulate.

Important Weekly Trend Test Today

Today is a very important day for the market, one which could make or break the near term bullish case. As you can see on the QQQQ (NASDAQ 100) chart below, $38 represents long time support, the trend it has been following since 2003. For the past two weeks support has held in this area and there are good reasons to assume that the price will hold here once again; not the least of which is the fact that end of the month buying should kick in today. On the other hand sell signals are flashing across the board after yesterday’s heavy retreat of the buyers. The market should bounce here, but we know that the market doesn’t always do what it should do, so we need to prepare ourselves for the other potential scenario that could develop out of a break down here. Should $38 give way this week, short set ups will be confirmed and we should look for the QQQQ to drop back to $36 over the next few weeks. Today is a great day to sit back and watch to see what develops out of this trend test.

Be Patient in Front of the Month End Buying Window

Traders have been nervous over the past couple of days as the bond market has been falling. Today’s scans revealed a plethora of short set ups and few stocks worth looking at on the long side. Looking at the market in a narrow time frame, forgetting to filter out market noise and swinging with the crowd here it would be very easy to jump from the bullish camp to the bearish camp. Interestingly enough however, when panning back to a weekly view, stocks that are setting up short are oversold and showing bullish divergences. Likewise, it is our view that it would be trader suicide to short the market a day before the month end buying spree kicks in. In other words, we believe we are seeing the making of a bear trap; a situation where shorts are enticed in right before bulls fire back. The bond market is bottoming and as mentioned numerous times this week, we expect buyers to come back in either today or Friday. There is a strong risk for bears that they will be caught on the wrong side of the tape and will get squeezed like they did a week ago Wednesday. This is a market that is rewarding the patient right now. Good set ups on the long side will come as the traps are sprung. We may or may not see lower prices today, but we believe that by Friday or Monday the bears will be screaming uncle! As always, we will wait for confirmation before we buy in to this theory. Today we will wait for better set ups.

Back and Fill Day

As expected, we saw some of Monday’s gains retrace yesterday. The fact that a majority of the gains held however is a positive for the bullish case. Likewise, the fact that the market closed strong shows that smart money is still using the weakness to add to their long positions.

Tech Pulls Market Higher

Yesterday was catch up day for the blue chips. The Dow was up 170 points and the S&P 500 up 20. Tech heavy NASDAQ however remains out in front and considering that the 5-day end of the month buying spree should kick in by Friday, there remains a strong possibility we will see tech break out of its trading range soon. Note the weekly QQQQ chart below. Two weeks ago it bounced off its 50-week average and long term trend line. Yesterday it closed just .34 below $39.50, a number which represents overhead resistance on its trading range. Its refusal to drop back to the lower support on its trading range betrays the fact that it has underlying strength. A weekly close over $39.50 will mean good times ahead for the bulls.

Today may give back some of yesterday’s gains. This market is once again climbing a wall of worry and a retracement of some of the gains will encourage the bears to get more aggressive again. This would be bullish since short covering combined with end of the month buying power could be the catalyst that pushes the QQQQ through overhead resistance.

Sector Rotation Into Tech

We start the week with the major indices, “The Generals,” diverging from one another. Most striking is the fact that the S&P 500 shows a weekly breakdown from a triangle pattern; volume over the past three weeks. Meanwhile, the tech heavy NASDAQ has enjoyed the influx from a sector rotation out of the oils and back into tech. Earnings reports have been positive for the most part and projections are looking good so smart money is moving back into this sector that has lagged since the market crash at the beginning of the new millennium. The QQQQ is right at support and showing some very nice weekly bullish divergences on its indicators. A retest of its recent highs is likely imminent and a breakout to new highs is back on the table as a reasonably probable scenario before the year is out. We are moving into the monthly buying window, which should have indices moving higher later in the week.

Market Buys the News as Bulls Come Back Strongly

Shorting yesterday would have had disastrous results. There’s an old saying: Never short a boring market. While this market has had an increase in volatility lately and the VIX has in fact broken out of its trading range (indicating an increase in volatility), the market over the past few days has been merely drifting. We were looking for the market to break lower yesterday, but because the signal was not clear we felt it better to stay sidelined. This proved to be the best course of action under the circumstances that ensued. Is the market ready to turn up here? That’s the big question that is now on the table. Today the S&P and NASDAQ alike put in a wide range bar, not unlike the way the market traded in early May and early June as the market rallied off the lows of what is turning out to be the market’s trading range. In fact, today was the largest wide ranging bar in nearly a year for the QQQQ. The last time such an event occurred was October 27, 2004. We encourage everyone to pull up their charts and see what occurred from that point.

Waiting for a Better Signal

There is a big difference between what the market should and could do and what it actually will do. For example, the market sold off hard at the beginning of the month and then last week strong signs of support appeared, which were confirmed by generally oversold conditions and overly bearish sentiment. As such the market COULD have and even SHOULD have started an oversold rally. What the market actually did do however is put in a weak dead cat bounce that is quickly running out of steam. Now we are faced with an altogether different set of market signals than we were at this time last week. The oversold conditions are working themselves off without a significant price level improvement. Now we find that the market COULD and even SHOULD sell off further from current levels making another leg down in the downtrend started October 4. But will the market do what it could and should do here? Since this is options week the answer becomes a bit more tricky. We think the market will make a new leg lower before it finds a significant level of buying support. If the market follows through on yesterday’s weakness the odds will more heavily favor such a breakdown raising the probabilities of success on the short side. Today is a good day to stay sidelined as we wait and see if yesterday’s weakness was the real deal or just a one-day wonder.

Volume Levels Problematic

If the market can hold on today gains made over the past two trading days this week then we are likely to see a run back to long term overhead resistance. If however the prices start to weaken at their current levels and start to roll over, then it will mean this market rally we are in was very short lived and had no steam behind it. Poor volume levels yesterday indicate that bulls may already be running out of steam.

Oversold Bounce, But...

It’s a tough call to make here as we move into options week. Stocks are oversold as well as indices, but the S&P closed the week below support – most technicians would agree that’s a warning sign that lower prices are yet to come. The NASDAQ on the other hand closed right at its long term trend line, though it is hanging by a thread. It must reverse and make a move higher from this level or a downtrend will be confirmed. Right now we are in the camp that believes the selling is not yet over, but that a near term bounce is fast approaching. We saw beginnings of such a bounce on Friday.

Oversold Condition Starting To Attract Buyers

There have been signs since Wednesday that some of the more oversold stocks are running out of downside momentum. The QQQQ, SMH, and have recently sliced through their respective 200-day averages like a knife through butter. Panic ensued and stocks were dumped more out of fear than from reason. A quick study of index history shows however that the 200-day average is not an area that falls quickly. Bulls will battle back for this average and further selling is going to get swept up by smart money who understand this. Who will win the battle is yet to be determined. It is almost a sure bet however that prices will start to bounce back up as the battle back from the lows begins. If bulls have enough weapons in their arsenal we could see a rally ensue from the ashes. If not, and prices merely limp back to their 200-day averages, then we are likely to see the downtrend resume. Right now however it pays to bet on the bounce; after which we will wait and see what develops from that bounce.

Bulls Losing Control Near Term

About the only thing positive we can say about the market at this time is that stocks are getting rather oversold and the QQQQ is at its 200-day average. Other than these two factors, the charts look to trade lower. Our bias is moving toward near term bullishness but we remain neutral in our assessment for the long term at this time. Though we believe indices are due for a bounce near term, the trades are still on the short side here. The short side is providing a plethora of set ups pretty much across the board. The market will have to bounce with conviction to reverse the poor technicals that have been developing recently. For now we believe it prudent to bet against a strong bounce as we believe that sellers have control for now and any bounce will be short lived.

Negativity Creates Opportunity

Yesterday the indices put in another real distribution day. Since the indices had sold down to support levels on Thursday a distribution day at support cannot be a good thing if you are a bull. As we said yesterday, we are not strongly biased about this market. It has in the recent past sold off below support levels only to recover and follow through with new gains. Even so, we are glad to see some real volatility return. The VIX has broken above its $15 resistance indicating some real emotion has been injected back into the game. This market is one that has been limping up to test support over the past year and over the past few months has experienced a noticeably decreasing level of breadth as fewer and fewer stocks participated in the gains. Now that we are getting some downside movement breadth has returned to 2-1 participation in the move. The key point to understand here is that the market is moving and that is a very good thing. We are not ready to use the word bear market here, but, keep in mind that bear markets create some of the best bullish bounces and provide for some of the best trading opportunities on both the long and short sides as prices oscillate on extreme fear and speculation. So, if the market does in fact not break out to new highs as we speculated last week, a break down to past lows can provide as many or more trading opportunities. Anything is better than a lazy trading range.

Conditions Neutral

After last week’s hard sell off stocks and indices are oversold. Of course in a downtrend oversold can become more oversold. So far however, only the NASDAQ has broken down. Unless other indices follow we cannot count the current environment as a downtrend. Stocks could potentially still pull back higher. If they are going to, they need to build a base at the current level, which will help repair some of the technical damage incurred last week. Scans today were not overly negative, nor were they overly positive. We start the week with fairly neutral conditions and we have no bias as to what will develop next at this time.

Market Congestion Problem is Clearing Up

After three months of moving sideways the market has finally felt an injection of activity. It is highly likely that a major move will emerge from the ashes of this week’s hard reversal that will likely last into the end of the year. At this point there are good arguments for why the move could go either way. If prices stick today and buyers come back in aggressively then we could see a breakout to the upside, which takes out old highs and puts back into play the scenario we were outlining last week. If the buyers remain timid and sellers continue to play offense taking out the 200-day averages, then we could see a turn south over the next few months that will do a lot of damage to the portfolios of long term longs. Either way, the congestion pattern is breaking up and trading volatility is returning, which can only be a good thing for our trading style.

Nearing a Bounce?

Yesterday’s strong bearish follow through drove the major market indexes down through their daily support levels. This selling could potentially take the market down to a climactic reversal point in tomorrow's session. There is a good probability that the open will provide an exhaustive gap to buy into. When there is blood on the streets, bottom fishers come out in droves.

Market Reverses Hard Mid Day

The market did a 180 degree turn mid day yesterday as bulls ran out of gas and shorts took the wheel. Bullish set ups from yesterday’s scans gave way to selling and today’s scans turned up a very bearish near term picture. The market is now undoubtedly heading back to August lows where we hope that it will find support. It is once again time to buckle up and get defensive as yesterday’s overall sell signal is one that should not be second guessed. Likewise, the gold and other metal sectors took a turn for the worse yesterday even as inflationary worries were reported. Add to that, even oil turned south yesterday. We may be in for a few days of wholesale selling.

Tech Bears Have Their Backs to the Wall

There is an underlying bullish bias that cannot be easily seen when merely analyzing market indices. The SMH and QQQQ both left bearish selling candles yesterday at their overhead resistance areas. This indicates that we may see indices retreat somewhat this week. However, drilling down deeper and looking at the underlying stocks themselves reveals an altogether different picture. After a dismal June, July the market rallied strongly off of support. At the beginning of this rally we found a number of stocks putting in double bottoms and we found other stocks trading in and/or breaking out of accumulation patterns. These same type of patterns have been showing up in our scans over the past couple of days. Today, after yesterday’s late day bearish market reversal, we find only bullish set ups in our scans. This is a strong divergence between the market indices themselves and we think it projects an underlying bullish current that is building in the market. We need the weekly signals, which we highlighted in yesterday’s report, to confirm before we can aggressively buy this market. At this time it looks hopeful. Note that chip stocks, despite yesterday’s late day SMH reversal, are doing rather well here. We uncovered several double bottom patterns in today’s scans that reveal and underlying current of continued recovery in this sector. ADSX and ATML are two good examples of what is taking place in this sector.

Very Important Market Test Coming Up

On Friday we mentioned that several major market indices produced a weekly buy signal. In particular, the tech sector has been at the front of this move as both the semiconductors and broader tech market represented by the QQQQ closed firmly for the week. Of even greater interest is the fact that the sector is now consolidating directly below major overhead resistance; the same resistance that has fenced in prices over the past two years. A break above this resistance would have very significant implications on our trading success rate. Over the past year especially the market has been trading in a coiling pattern as prices bounced between support and resistance without making any forward or negative progress. This has left many trades cold as breakouts and breakdowns have been faded, causing both to fail. Should the QQQQ break through overhead resistance, we will find that stocks will start to make some good moves, develop better trade set ups, and actually follow through from those setups. We look forward to the next few weeks to see what develops out of this situation. Note that the QQQQ is trading just below weekly resistance. A break here could have a significant impact on trade development. (A failure here would have prices moving back towards $36 support where we would expect a regrouping effort followed by another attempt at $40 resistance.)