Securities Research Services

Monday, August 14, 2006

Indices Trading at Resistance

We start options expiration week with sentiment in neutral and with tech indices poised for another leg lower. There are several reasons we think that tech has more downside left in it before it finally carves out some meaningful support. First, the downtrend is still in tact and with prices trading right at resistance levels, sentiment figures, as mentioned above, do not reveal a great deal of concern. Should the crowd be overly bearish here, we might be more inclined to look for a breakout that surprises the crowd, but this just isn't the case. Second, our scans reveal an abundance of stocks trading in bear flags with technical indicators that are overbought. This has occurred due to the fact that the market has bounced softly in relief from the last down leg, which has put many stocks right up against their falling 50-day averages. Pros enter trades at the 50-day average. Finally, the QQQQ has made two recent attempts to break the downtrend, but was rejected on both attempts. Moreover, volume on the rejection days exceeded volume on the subsequent recovery days by a margin of nearly 2:1. Note the chart below. We have highlighted the rejection days and have drawn lines connecting the volume bars representing those rejection days. It is clear that distribution continues to exceed accumulation at this time. Understand that no one can possibly know what the market will do next. All we have to rely on are probabilities. It is important to short when it is scary to do so; when stocks are trading up against resistance and when you are afraid that resistance will be broken. Just like it is important to buy at support when everyone is worried and when your own emotions are telling you "don't do it, support might break." Why? Because it is at these times that probabilities are most strongly in your favor.

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