Securities Research Services

Friday, August 18, 2006

Has Everything Suddenly Changed? Don't Bet on It.

All last spring and most of this summer, strength has been sold into. Early this week we had a similar situation, where the market had been trying to rally, but had been knocked back on each attempt. The market is often perverse though and once the pattern of selling strength was well recognized, it did the opposite of what it was projecting and gapped over resistance. Moreover, we have yet to see a real pullback in this trend. Readers will recall that we had a similar situation in May, only in reverse. In May, the market broke down from its long term trend and then traded straight down without one serious pullback. The QQQQ traded down $4.00 before it experienced a 50% retracement of the move. Now we have a mirror-opposite of May's down move and the QQQQ has traded up $3.50 from its lows, again without a pullback. Today is expiration day and a close near $39 on the QQQQ would cause the maximum amount of pain for the maximum number of options buyers as it would cause many of their put options to expire worthless; this after tremendous profits had been logged from the previous few weeks. Interestingly enough, $39 represents the QQQQ's 200-day average and a 50% retracement of the entire downtrend started back in May. In other words, there is some tremendous resistance at these levels. Getting back to lessons the market teaches us: the market taught us that it is good to sell strength, then, once the lesson was well learned, it perversely changed the rules. Do we now buy strength? We argue firmly, No! If the trend has changed, then we will see an orderly pullback from this major resistance level and dip buyers will be eager to get in. If the trend has not changed, we will see something of a panic ensue when dip buyers are not to be found. Today we should see the QQQQ trade near $39. A move slightly over $39 in the next few days is possible, but we would consider that a good opportunity to sell strength. A pullback from this area over the next few days to a week is about as sure a bet as bets go in the market. It is the character of the pullback that will be most telling.

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