Probably a Top, But Tops Take Time to Form

The trend is showing signs of topping as money flow figures have been decreasing even as prices have remained flat. Tops take time to form since smart money sells into rallies slowly in order to avoid a panic before their positions are unraveled and they have been able to put on their shorts. It is very likely that this is the process that is occurring at current levels. Meanwhile, overly eager bears keep trying to short this market. We think they are too early. In fact, there are a number of stocks where bears have been pressing too hard, trying to break stocks down against the still in tact uptrend. This is a situation that is likely to lead to a series of false breakdowns and short squeezes that can be taken advantage of.

Economic Trend in Rapid Decline

The trend is your friend is pretty much the basic battle cry uttered under the breath in mantra-like repetition of any experienced trader. On Friday the market got a fair look at the economic trend that has been unfolding with the release of the GDP report. The government has done decent job of covering up the declining economy and has given the market the impression that a "soft landing" was in the cards. In fact, economic growth has been in rapid decline, indicating that the recession projected by the inverted yield curve may in fact be right around the corner and not later next year as had been originally projected. The stock market reacted to this information by selling off against the underlying uptrend in a fashion that we have not seen since this trend began last summer. That was probably the warning shot across the bow. Wall Street has been doing a good job keeping this rally going and it seems unlikely that they will let go of this agenda prior to the elections next week. Likewise, as we mentioned, mutual funds are scrambling to put their latent cash to work as they close out the books on their fiscal year. These two factors should keep the current trend alive. That is to say that last Friday's sharp decline should be met with a sharp contra rally back up to the latest highs. There are signs, however, that this rally has finally hit the wall that will turn it back. Money has been flowing out of the Dow, which is a very different technical development from what was occurring as this rally was underway last July. Likewise, the semiconductor sector, which is a leading indicator for the tech sector, is developing a head and shoulders pattern and has met with sharp distribution on each move up to the upper end of its trading range. The S&P still has good money flow, which may be due to the fact that mutual funds are busy putting their money to work. The trend in this sector could continue for a while, while tech starts to diverge through underperformance. We will be using today to look for stocks that are rallying weakly back up to broken support in order to start balancing out our open positions with some shorts in the weaker sectors.

Top Callers Continue to Take on Haphazzard Shorts

We find it quite amazing that this bullish move has yet to reach the point of recognition where the bears finally capitulate and turn into longs. Shorts have been hitting this rally since the market bottomed back in July. We admit, we were skeptical and made our own mistakes trying to call a top up through September, to which we plead mea culpa. After the market showed that dip buyers continued to be as aggressive as we have seen in recent memory and once the small caps started to participate, we threw in our top calling towel and went with the flow. Thus far, it has been quite profitable to do so. Top calling persists in this market and shorts continue to attack the rallies. Yesterday QQQQ bears bought twice as many puts as they did calls. They may get lucky, but what we continue to find in this market are very nice buy set ups and a shear lack of distribution; just the opposite in fact, for every dip has found aggressive buying. It doesn't pay to throw caution to the wind here. The market remains technically overbought. At the same time, just because it is technically overbought does not mean that it cannot continue to climb higher. Strong market moves always go much further than most think probable or possible. We continue to warn against exuberance and at the same time warn about trying to call the top. Take the bullish set ups as they come and use stops to take you out when the market finally does turn. Gold is once again heating up, so pay attention to this sector.

Probabilities for a Correction Increase - But Don't Short Yet

Underperformance in the QQQQ compared to the SPY yesterday warns us that a correction is nearing. However, the QQQQ closed back at support and bears who shorted early are likely going to feel pain once again. The adage "be slow to go short" should prove true once again. One of these days – probably sooner than later – the top callers will be right. This market is feeding the top callers a great deal of pain though so it's best to just keep good stops on longs rather than going aggressively short here. One possibility we may see over the next two weeks is a tech sector that underperforms, but refuses to roll over, while the Dow and S&P continue to scratch out minor gains. We doubt that this market is heading for an exhaustion top here. Rather, it seems more likely that a healthy pullback will be the result of recent gains. The expected pullback would likely be a buying opportunity rather than a signal to go short. This is of course just one possibility out of many potential possibilities. For now, we remain in an uptrend, which is in tact until it is not.

Dip Buying Remains Strong

Bulls continue to relentlessly buy the dips as last week's dip back to support was followed by an explosive move back to the latest highs yesterday. What is most interesting here is the number of analysts who continue to doubt this market's move and the number of traders who continue to short the highs. In other words, this bull market has not yet reached the "point of recognition" where nervous retail longs finally realize that this is indeed a bull market and put money to work. They usually do so at the top, right before a correction. We have stopped trying to predict where this market may turn. Right now we strongly advice just taking what this market is giving – good long set ups – and leaving the top calling to those who are likely to continue fueling this move with their short covering. Protective stops should be used to take us out, not our human tendencies towards fearing the unknown. We read a great quote the other day: "if the market rewarded human nature, then nearly everyone would succeed." The wisdom behind that quote speaks volumes.

Trends are Bullish, but Extended

The QQQQ continues to look tired here. If it can make it back over $42.50 it is going to put a real hurt on a heavy institutional short position that is already hurting badly. However, if gets sold back down to $41.50 it will signal the beginning of a larger correction. The S&P and Dow both look much stronger, and while they are oversold and at risk for a pullback to their trend lines, dips remain buying opportunities. The end of the month should once again see a good rally take place. Since options expiration was last Friday, however, we could be in for some weakness as we start out the week this week. It is best not to get too aggressive until prices come back to better support levels.

Dip Buyers Continue to be Relentless

The sector to watch today is the semiconductors, which we like to track via the SMH. It has pulled back harshly to its 50-day average. If the current trend stays in tact, we should see it bounce today, which would prop up the QQQQ. Money flow into the blue chips continues to be good and even the tech sector has been finding late day support. Remember, the amateurs trade in the morning and the pros show their cards into the close. Pros have been buying the close for the past two days. So again, we remind everyone, don't be too quick to become bearish. The market may be overbought and may be near resistance, but signs of distribution are hard to come by.

Waiting on the CPI Reaction

Yesterday's PPI numbers gave the market a shake, but by the end of the day the Dow and S&P had almost fully recovered as dip buyers remained aggressive. A crack in the market's armor showed, however, as the QQQQ and semiconductor sectors reacted more harshly to the higher than expected inflation numbers. Likewise, the tech sector failed to make the same strong recovery that the blue chips were able to carve out. We are still projecting the rally in the blue chip sector will stay in tact for the next couple of weeks (and perhaps up through the November 7 elections). Tech, while not likely to turn into a downtrend just yet, will probably start to lag as it did last spring. Today's CPI numbers, if as inflationary or more so than yesterday's PPI, have the potential to knock the QQQQ back to support near $41.

Be Slow to Become Bearish

We could be facing a "turnaround Tuesday" today as indices looked a bit tired yesterday. We need to warn traders to be slow to turn bearish however. Dip buyers have been as aggressive as we have seen in some time and there are no signs yet that this is about to change. Breadth remains good and our scans continue to reveal a bullish underlying picture. The tech sector looked especially tired yesterday, but bears were aggressively buying puts at rates nearing 5-1 over calls. With so many betting on a top here it is unlikely that a top is in just yet.

Charts are Great, but Protect Your Gains

We would like to make two points today. First, don't forget where the indices are. Those betting on a large upside breakout at these levels are betting on the greater fool theory; that there will be an even greater fool to buy at higher prices. Keep cool here even if (especially if) the market goes into a panicked buying mode. Second, just because resistance is overhead and indices are not likely to make much progress, trade what is in front of you. If set ups are good, take them and protect yourself with a good stop loss strategy. Right now set ups are very good. Yes prices may turn at any time, but no one made any progress in the market worrying about what "could" happen. You have to take the opportunities that the market gives you and protect yourself against the turns by using good risk management.

Next Friday's Expiration May Cause Shorts Pain

The interesting thing about this rally is that it was never trusted. Even now with the market breaking out to new highs, there remains a high level of distrust. With options expiration a week from today, that distrust, which has caused aggressive shorts to sell into the strength, is likely to keep prices moving higher. Why? Options expiration generally works against those who have the potential to feel the greatest amount of pain. Right now it is the aggressive shorts that are getting squeezed, so the pain from expiration is likely to be pressed against them.

The Trend Remains Long Friendly

The bulls showed that they are still in control after a private plane crash in NYC caused a market scare. Volume on the recovery shows that bulls are still holding out for higher prices. As we stated yesterday, the trend is up until it is not. Right now it is up and it pays to stay long.

Keeping the Big Picture in Mind as the Market Climbs

We wish to keep today's report simple. We want to point out just a couple of points, that we think are important to keep in mind at this market juncture. First: the market remains in an uptrend until it's not. Until we have confirmation that the trend has broken, do not short dips or get scared and exit at dips. In other words, the long side is where the path of least resistance remains. The potential for a reversal is high, but the trend could possibly last until elections on November 7. Second: upside potential is small and downside potential is huge. Do not get carried away with the crowds buying breakouts at these levels. Breakout buyers at this stage are likely to end up as bag holders. On the chart below we have outlined where the QQQQ is at. As you can see, upside potential is muted, while downside risk is large.

No Update Today

There will be no report today due to traveling conflicts. Market conditions remain very much the same after Monday's session. There is no need to get agressive on the long side, but going short is probably premature at this stage.

Bulls in Control, but This is Their End Game

On Friday the market dipped, or rather the uptrend slowed, and options traders once again got bearish. No doubt about it, this bull run is in its end game here. Even so, as long as the crowds continue to get bearish on dips, the uptrend is likely to continue to chip away at their trading accounts by stopping out their short positions. The reason for this is relatively simple. The market rallies and the crowds get bullish. Short term profit takers sell the strength and the market dips. The crowd suffers a bi-polar-like mood swing and gets bearish, opening up large short positions as they attempt to pick the top. Subsequently, the trend (which is still up) reasserts itself and the new short positions add fuel to the rally as the crowds are forced to recover. This cycle will spin the market higher and higher and is the mechanics behind the phenomena oft referred to as "climbing the wall of worry." Eventually though, the crowd will learn the lesson and will begin BUYING the dips instead of selling them. When this happens, we can count on the fact that the top is either in place, or very close to being there. This week we wouldn't be surprised to see some consolidation or even pulling back. With the QQQQ and SPY both a few points away from overhead resistance, we would not count the uptrend over yet – especially with the crowds still selling the dips. Most likely longs will be tested this week and then the market will make another run higher before the uptrend finally starts to show signs of ending. Understand two things here and you will do well this month: First, this bull run is in its end game and downside risk far exceeds upside potential. Second, be slow to turn bearish, lest you find yourself being stopped out as prices refuse to follow through lower. In other words, wait for confirmation before going short, but don't be too aggressive on the long side.

Why Wednesday's Changed the Outlook

The Dow actually pushed above long term overhead resistance yesterday. Breakouts here are quite suspect, but momentum has the potential to push the market higher through the month, with a bit of backing and filling along the way. Risk increases now as momentum traders take over. For now we will try not to make any sweeping predictions and just ride the trend. As long as we continue to see decent set ups, it makes sense to stay long, using stop losses to protect against a price reversal. When this market comes down, it has the potential to come down fast. Until it does, however, this is no market to be short and long positions should continue to pay off. One brief comment about Wednesday's trading. Prior to the high volume, wide-range day on Wednesday, the market was at a pivotal point. Indices were at resistance. The market was likely to do one of two things that day; either break down or break out. Comments from the Fed helped it break out, which is why we were forced to shed our bearish posture. With the QQQQ breaking over its inflection point on Wednesday, odds seem pretty good that it will work its way back up to test last spring's highs. As it nears those highs, make sure to take profits into strength, but be slow to get bearish. This two month uptrend is at some point going to go through at a minimum a 50% correction. Until we get confirmation that the trend has rolled, however, over, it is a good idea not to sell the dips.

Bulls Deliver a Potential Knockout Blow

On Monday the QQQQ broke down from the rising wedge pattern we have been concerned with. Then on Tuesday the price rallied back to test broken support (then resistance). We were waiting for confirmation in the form of a follow through lower from that test in order to trigger a reason to get heavily short. Yesterday the market voted and confirmation was not to be. Essentially what we have after yesterday is a failed breakdown in tech and a rally which occurred with broad scale buying. Failed breakdowns must be respected for they generally lead to hard rallies. Over the past two months we have provided a lot of reasons why the market should not rally. The market has disagreed for whatever reason. Some suggest that there is a concerted campaign to pump and rally the market into November's election season. We don't know. This explanation is certainly as good as any other because the obvious reasons for the rally just don't add up. Whatever the case, a few important things have changed since yesterday. Market breadth was good, as was new highs among individual stocks. Scans, which have been dismal for the past few days, have now turned up quite a number of bullish set ups. Likewise, the Russell 2000, which had been lagging blue chips badly, has moved up to test resistance and is threatening a breakout. Should small and mid caps take over, the ensuing rally could be strong. At times like this, it is important to just take your lumps and admit defeat. In other words, if you can't beat 'em, join 'em.

Is a Rising Dow Bullish?

The media is cheering on the rising Dow as it pushed to yet another new all time high yesterday. Traders are hyping a rotation into the blue chips, arguing that we are entering a new era where blue chips will lead. We have to ask, these really bullish developments? By our readings, not really. The flight to blue chips is more indicative of institutional money that is getting nervous about the market. They have been moving out of the speculative small cap stocks (just check the Russell 2000 ETF IWM to see) and into the highly liquid blue chip sectors. This is what occurs at market tops not at market breakouts. And, since the Dow is leading let's take a close look at it. Below is the weekly Dow chart. Note that weekly resistance is at 11,840; just barely more than 100 points from yesterday's close. The Dow has been turned back at this rising resistance line each time for the past 2 1/2 years. Why should we expect this time to be different when tech lags and when speculative money is running for safe havens?

Note that the QQQQ accomplished the first leg (the up arrow) in the scenario provided yesterday. Now we wait to see if it will indeed be turned back at this area.

Bulls and Bears Likely to Be Frustrated this Week

Today we have two slightly competing theses confronting the market. First, the QQQQ broke cleanly from its rising wedge pattern.

Second, too many traders have been waiting for this break and put options sales were through the roof yesterday as a result of the break. When too many people in the market are looking for the same thing, the perverse nature of the market is to deny the crowds their satisfaction. We scanned everything today and there are just not good chart set ups out there despite the QQQQ breakdown yesterday. Longs are very likely to be frustrated as rally attempts should now get turned back at resistance. Likewise, eager shorts are likely to be frustrated today as follow through from yesterday's breakdown is unlikely. Very often when a major breakdown occurs, the underside of support is tested before the trend can establish itself. Evidence points to a test of resistance that gives false courage to bulls and frustrates overly anticipatory bears before the market can move lower.

We highly recommend not forcing a trade here. When stocks are not setting up the best policy is to wait until they are. Let the other guys struggle against the trendless environment and save your cash to take advantage of the situation once the smoke clears.

Friday Was Probably Meaningless

On Friday it looked as if institutions had achieved the prices they wished to close the quarter out at for the day was locked in a tight range. Breakouts where confined as sell programs kept a lid on things and then when prices started to roll over, buy programs put in just enough bids to keep prices from moving lower. As such, it's hard for us to make much of Friday's action and suspect that what happens today will be much more meaningful as far as helping us to determine what to expect next. The rising wedges on all three major indices should be the driving force that favors sellers this month. Today we would expect sellers to gain control of the market, but with last week's mixed messages, we are not making any strong predictions here. The most curious aspect of Friday's market was trading at the option's desks. Nearly 10 call options were purchased for every put option on the OEX desk. This is certainly drastically overly bullish, but when you get numbers like this, there could be alternative explanations that are much more benign. We'll just have to wait and see how today plays out.