Wednesday, July 12, 2006
In yesterday's report we outlined our thesis arguing that the market was under extreme distribution, but that shorts would likely be shaken out of their positions before the market turned significantly lower. Yesterday's late afternoon rally fits the thesis and if we are right, we will see the QQQQ rally sharply higher over the next few days to fill the gap near $38.90. The pros call this process "creating a shelf of distribution." It is to the benefit of institutional money to exit their positions at higher, rather than lower prices. If they can get the market to work its way higher buyers will create their own self-perpetuating momentum. This type of trigger tends to exhaust itself quickly since smart money uses the momentum to sell into. There continues to be evidence of distribution as money flow figures on some major sectors are turning down as prices turn up. Using this momentum to sell into appears to us to be the highest probability play. Understand that we, or anyone else, do not actually know what is going to take place in the market. The market is all about probabilities. Our work shows that the highest probability play will be to sell into this minor rally we expect will take place over the next few days. If we are wrong we will see stock set ups start to improve. The downtrend is still in effect and there is no money to be made in calling an exact bottom. If the trends turn back higher, there will be plenty of time to go long again as stocks back and fill to build support. It will be interesting to see if the market can rally sharply higher today the way it did on 6/15 and 6/29. Note the fact that after those two rallies distribution took place and no real follow through was realized. There does not appear to be any sense in grabbing long exposure for a one day rally (if it is to play out like this yet again). We will do better to sideline ourselves today and look to see what develops today and perhaps tomorrow. Options expire on Friday, making any rally equally suspicious at this juncture. The bottom line: This market is not providing high probability set ups and due to its one-day-up, one-day-down nature, the chances of getting whipsawed are very high.