A Battle Rages

Before running through our scans we were of the opinion that it would be necessary to put on a short hedge or two. After getting a clearer view of the internal character of the market that is better seen when viewing individual stock charts we have determined that there is no clear direction in this market despite the seemingly strong reversal on Tuesday. Stocks are not set up to run at this point but that does not mean that they are set to break down. We saw very few reliable short or long set ups and considering the fact that the broader market is so mixed, we can be fairly confident that set ups that do look promising are in fact unreliable. Bears controlled the day today. They have not gained control of the market yet. There is one near certainty that we can uncover at this point: those who try and enter the fray as both sides battle for control are going to come away with losses. This is not an either/or situation. This is a lose/lose situation until one or the other side gains control.

A Defensive Posture is Important Here

We saw the market moving up today but volume left much to be desired. The reversals on the S&P 500 and Dow are a warning sign as are low volume levels and continued poor breadth. We expect the rest of this week to remain fairly positive but we would like to be very careful here and take precautionary measures like putting on some short hedges. We don't know what the market is going to do next so pragmatism is demanded here.

Bulls Have Their Work Cut Out, but Remain In Control

Breadth and volume were poor yesterday, which means we need to exercise caution. There are however some positives that could keep the market afloat for a while longer. Weekly charts on the NASDAQ continue to show strong buy signals and the prices, though choppy this week, have refused to break down through supports. Another positive is the fact that money is starting to flow out of the Dow. Recall that the bearish case was built on the fact that institutional money was parking in the Dow out of fear that a top was forming. With money moving back out of this dinosaur it indicates that fears are subsiding and that money has an opportunity to flow out of the blue chips and commodities (which continue to correct hard) into the broader market. The last positive for the market here is found in our scans. Scans today revealed a mixed picture. A number of stocks are showing strong inflows of money while another group of stocks that have been underperforming are showing strong signs of being oversold. Market tops are not marked by large numbers of stocks in oversold conditions. The bottom line here is that there is indecision here, but the bulls have the power to pull the market higher. Bears have a weak case and are losing strength, but the bulls have to capitalize. The correction in the commodities sector could influence the fed to tone down its hawkish comments, which could give the market a real boost from current levels.

Market Bouncing on Poor Breadth and Volume

The market is bouncing into the end of the month here, but we would look for more volatility today. Breadth is very poor and momentum has all but died out. We may get a stronger rally next week but right now long positions are really struggling to make decent gains. Bears are convinced we are at the top. We wouldn't go so far as to make that prediction at this point. We do however want to exercise caution and proceed with care until breadth and momentum improve. The energy sector is correcting, which could lend to a sector rotation into tech. Right now money is moving fairly aggressively out of energy, but has yet to move aggressively into tech. As such we would focus on shorting energy here. We do not recommend opening new long positions until the picture clears up a little.

Bears Growl, But We Expect a Push Higher

Blue chip stocks continued to hold near their highs yesterday as tech continued to experience pressure. The slow drift of stocks here can be much more frustrating than a quick downside move since it make support levels bend but doesn't clearly break them. This activity has caused options traders to heavily buy puts into the dips in the tech sector. Logically this makes no sense since they are betting on a breakdown before they have confirmation. Options traders are typically not logical traders though, but rather emotional traders. The actions of this group make for a very strong contrarian buy signal. This is confirmed by the fact that weekly charts are showing strong buy signals even as daily charts are experiencing weakness. The weekly view is always more accurate. We are looking for the tech sector to make a good run as we head into the end of February, which should last into early March. We don't know what will happen after this run. Some are getting quite bearish here, but we plan to just play what is in front of us and not let convictions override reason.

Dow Breaks Higher

Blue chips are outperforming tech here, which is causing some to start discussing a market top. We are dubious of this claim at this point and will need to see stronger evidence than strong performances in large cap stocks to make us get long term bearish. The NASDAQ has a weekly buy signal and there is a good chance we will see tech make a strong move to catch up over the next few weeks. Right now we fail to see any distribution activity that marks a market top. As we stated, the market will make a monkey out of the greatest number of people and this is a good opportunity for it to make a strong run and fool the majority. On Friday we mentioned that the SPY was poised for a weekly breakout. In fact the SPY is poised for a weekly breakout, but the report contained a mistake. It was actually the Dow ETF DIA that was poised to break out last week. The DIA closed over the magic number of $110 and broke out over long term resistance.

Looking for a Potential Strong Close Today

All eyes should be on the S&P 500 today. If it's ETF (SPY) can close above $110, and we will have a weekly breakout. The NASDAQ has lagged, but it is moving nicely off of its trend. Likewise, the semiconductors are gearing up for a strong move off their breakout support level. A strong weekly close today would put the market in a strong technical position to make a very nice run. There has been a lot of doom and gloom about the longer term outlook of the market lately. A lot of it surrounding the unknowns related to the changing of the guard at the Fed. Perhaps the market is going to surprise a lot of people and start trending to new highs. If there is a certainty in the market, it is that the market always surprises the greatest number of people possible.

Blue Chips Breaking Out

The NASDAQ continues to carve out a bottom, the Dow and S&P threaten to make new weekly highs and the semiconductors continue to threaten a new leg up after spending the last 12 weeks consolidating support above breakout levels. At this point we don't have an opinion about how strong the run will be, but the market is certainly behaving very bullishly here. What we do know is that if the blue chips can close above weekly highs this week and the tech sector makes a move out off of support, we are going to have a very nice group of solid trade set ups that offer a good balance between risk and reward. Be patient here because the market is setting up very nicely.

Base Getting Stronger

The big news of the day is the Dow. It is once again threatening the 11,000 level. If the current price level can hold through Friday, there will be a weekly breakout on the Dow chart. The S&P 500 is also trading near recent highs. The running theory is that money is flowing out of small caps into the blue chips. If so, we could be in the last stages of the bull market and could potentially see a larger correction in coming months. For now though, it is best not to try and speculate too much and just play the charts in front of us. Sweeping theories about what the market may or may not do don't make anyone any money, they just cause traders to lose focus and make bad decisions. The QQQQ is building a strong base here and while we could still see choppy trading into Friday, we expect a rally to ensue from this area. As such, dips remain buying opportunities.

Look For a Hard Reversal This Week

Last week we provided two scenarios that could possibly take place as the QQQQ struggled with its downtrend. One scenario looked at the possibility that traders would become overly bearish and the index would stretch down to a very oversold condition setting up a great buying opportunity. The second scenario, which did in fact play out last week, had the QQQQ bouncing to relieve its already oversold condition, filling the gap, and setting up for a new leg down. So here we are. The QQQQ is making its new leg down after filling the gap at $41.50. Do we get bearish here then? No! Instead, the first scenario is now back in play. The index is now getting very oversold and it has long term trend support just below $40. Yesterday the QQQQ closed at $40.49. While this occurred 55k puts were sold and only 22k calls were purchased. In other words, options traders, who have an absolutely horrible record, are betting on a breakdown. We are betting they are not going to get it. Stated another way, dumb money is betting on a bearish case and smart money is accumulating at these levels. This week options expire and bears likely have a target on their backs. We are looking for a sharp bounce higher at some point this week. Scans today reveal that the selling pressure is not yet behind us, but QQQQ dips down to and below $40 are wonderful buying opportunities.

Options Week Kicks Off

The bounce on Friday appears to have been just short covering as profits made last week were locked in before the weekend. There are still a few issues trading independently of the indices, but the broader market does not appear to have solid support yet. Considering the fact that this is options expiration week, expect games to be played. We will be looking for the QQQQ to make another stab lower and suspect that this week will see base forming around the $40 area. During this period dips should be used to accumulate, but we do not recommend buying breakouts. Though we will likely continue to experience some selling pressure this week, it is far too late to short this oversold market.

Sector Rotation Underway

As you can see from the QQQQ chart below, this market has not yet found a floor. Yesterday's sell off after the gap fill projects at least another minor leg down. We suspect that options games played during expiration week next week will shake the QQQQ down below $40 to get the crowd really bearish. This would be a great buying opportunity. Strangely enough, individual stocks don't look nearly as bad as the index charts do. This looks to us much more like sector rotation than it does a serious trend threat. Money coming out of commodities is starting to move to other areas; we think tech. There certainly hasn't been the broad selling pressures that are taking down the whole market here. Yesterday there was some late day program trading that shook a lot of stocks, but most of them recovered quite nicely into the close as bargain hunters snapped them up. Shorts are likely to get burned in the next week or two.

Nearing a Bottom, But What Kind?

We continue to analyze the QQQQ, as it has been the leader on the rally up, and now leads the market down. When it finds support and reverses, it is very likely that the rest of the market will take its lead. Note that the QQQQ has a large open gap up to $41.43 and then a very small open gap up near $43. The large open gap represents a break of the neckline on a head and shoulders pattern and likewise, a break below pivot support. This break indicates that there will be no real support until the price touches down or moves just below $40. One of two things can happen here. Scenario 1: The market will bounce and the QQQQ will move up in a weak thrust to close the open gap above $41. This would be bad for the bulls and we would look to short the bounce under this scenario. Scenario 2: The QQQQ continues to bleed here and refuses to bounce even though it is getting oversold. The price would then stretch down to or just below $40 over the next few days. This would be great for the bulls and would lead to an excellent buying opportunity for what would surely be a strong rally, perhaps back up to or even above January's highs. For now we hope for Scenario 2 to play out, but will prepare for Scenario 1 just in case.

Gearing Up for an Oversold Bounce

The strong trend that started last October has not broken down but over the past few weeks it has grown soft. The market seems a bit confused here and a trading range has emerged. The technical picture has become a bit murky as a result of a hawkish fed statement and some poor earnings reports from key companies this earnings season. At this point it is useless to try and make long term predictions about where the market might go. To do so would just be an exercise in futility. In situations like this we have to follow the acknowledge what is right in front of us and forget about what may or may not happen a few weeks down the road. So what do we have in front of us right now? We have a nasty head and shoulders development on the major indices. Even so, the neckline support on these patterns has held on all but the NASDAQ 100. The breakdown of the NASDAQ 100 has not encouraged follow through and it looks like buyers are once again accumulating in anticipation of an oversold bounce. How strong will the bounce be? We have to wait and see. If the bounce is weak, it will be a good shorting opportunity.

Trend Weak, But Not Yet Finished

Despite the head and shoulders patterns showing up on major indices, we have not yet found signs of major breakdowns occurring, which would indicate that it is safe to short the market here. We are likely to get a bounce early this week. Unless the bounce is unusually strong, it will likely provide an opportunity for us to ease into a few short positions.

In a Trading Range Until We Are Not

Conditions haven't improved much since yesterday. At the same time we are really struggling with the reasoning for going bearish at this stage. There are two reasons for this: 1. The put:call ratio is overly bearish meaning that too many are leaning short here. Since the crowd is only right during the end of trends, this contrarian indicator is fairly reliable here where the market is in a trading range. 2. Indices are trading in head and should patterns, but the neckline on these patterns has not yet been breached. Anticipating breakouts or breakdowns is always a loser's game, so until we have confirmation, we remain agnostic about a breakdown. For now we are still in a trading range. Perhaps the Amazon report issued after hours will be enough to cause selling through support today, but right now support just below yesterday's close is still fairly strong.

Strong Move is Near

We are still concerned about the market rolling over here, confirming the head and shoulders pattern developing on the major indices. However, closer analysis of daily charts and considering the Russell 2000 is once again threatening new highs, a strong case can be made for the bulls here. Put options have been stacking up at these levels, which is a good contrarian indicator that bears are going to get burned as market momentum threatens to iron out overhead resistance. We don't know yet what is going to happen but it is fairly clear that a strong move is close at hand. Likewise, we have a lot of stocks in the market making new highs and very meager numbers of stocks making new lows. Other than a week ago Friday, we don't have evidence of distribution, but we have plenty of accumulation days and yesterday can be included as one.

Index Divergence Problematic

The indices continue to diverge as the Russell 2000 inches higher and the S&P and NASDAQ set up to roll over threatening to finish off the head and shoulders pattern we have been warning about this week. GOOG sold off in the after hours session last evening so we should have some fireworks today. Frankly the market is set up ideally for a short entry. Our only hesitation is due to the fact that we are in a traditionally bullish time of the month where surprises favor the bulls 70 percent of the time. So, rather than get aggressively short here, we recommend playing defensively, keeping tight stops and not opening new positions.