Securities Research Services

Friday, June 16, 2006

Why We do not Think a Bottom is Yet in Place

The last two days we have seen a rally nearly as striking as the crash we experienced earlier in the week as last Thursday's reversal day didn't stick. Many want this to be a bottom but we believe that it is not for several reasons: 1. Today is quadruple witching expiration day. The QQQQ and SPY price rally over the past two days has simply moved these two ETFs up to their maximum pain prices. This is called "parking the car in the garage" by Wall Street traders. In other words, the prices have simply moved back up to the point where put sellers maximize their profits and where put buyers over the past few weeks have watched all of their profits erode. Coincidence? 2. The put/call ratio on the QQQQ has gone from 4-1 in favor of puts at the beginning of the week (overly bearish) to an overly bullish 2-1 in favor of calls. This wild swing in sentiment from the bear to the bull side by this group of traders who are almost always wrong at the extremes simply indicate that this wild ride we have been on is not yet ready to stabilize. When two calls are purchased for every put the market will usually reverse lower within a day or two. 3. The QQQQ has only rallied back up to tag broken support between $38.50-$39.00. The SPY has only rallied back up to tag its broken 200-day average. These are classic throwback patterns up to resistance. Pros will use these types of throwbacks to put on shorts and to exit longs that they have been burned on. The market may indeed have put in a bottom but the odds are strongly against it. Longs have a lot of proving left to do. Until we see real capitulation and bottom-building activity we have to recognize the fact that the trend of the market is now down. We are looking for a more significant bottom to form later this month. Right now though surprises are most likely to occur in favor of the trend and again traders are too bullish and the trend is down.

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