Tricky Tape after Distribution Day

Today is May Day, but it was Monday that was most unfriendly to free markets everywhere.

Bears have an opportunity here. Despite the fact that there are too many shorting this market, technically indices have the potential to roll over here. All it would take is one good follow through day from yesterday’s selling.

This is a very tricky tape here. For we have seen this set up many times over the past 8-9 months, and as often as not bears have proven to have fired all their shots early and bulls step back in to buy the dips.

The bearish argument here is: a swift loss of last week’s momentum, overly bullish sentiment by some readings, a heavy distribution day yesterday, and a broad range of indices in danger of rolling over.

The bullish argument here is: too many put buyers eagerly shorted the indices yesterday, the broader trend is up, and bears may or may not be out of gas.

As you can see, the bearish argument has a bit more “oomph!” to it.

Even so, this is not the type of trading environment that is easy to make money in by any stretch of the phrase. Trying to nail down a top is just as dangerous as fighting the tape. In other words, it is not an easy decision to make whether or not to approach the market as a bull or a bear today. It’s probably best to sit back and take a neutral position of “wait and see.”

Weekly Momentum Very Strong

This market has its doubters; many of them. This is a healthy sign of a good trend though. Panning back to the weekly charts and it is possible to see momentum on this rally is very strong. Dips along the way are certainly possible, but this is a strong uptrend, the semiconductors broke out, and the QQQQ is threatening to break out.

If the QQQQ breaks out, things are going to get really exciting.

Consolidation Day

Yesterday represented consolidation, so there isn’t much to add to our recent analysis. A decent level of skepticism still exists, which indicates a healthy level of worry for the market to scale.

Long with trailing stops is the way to play the market here.

Market Powers Higher

The math is simple here. Bulls pushed market indices past resistance yesterday. Volume has been steady. Breadth, which we complained about yesterday, improved immensely, and to top it all off, the put:call ratio leans heavily in the put camp.

With no one believing this rally and with stocks and indices striding ever higher, the market looks very similar to last August, when to no one believed and prices just kept marching along without pulling back.

It will end sometime, but right now it’s best to be long and along for the ride. When it ends stops will take us out.

The Bullish Case

Yesterday we discussed conflicting data points, which were keeping the market in a range of indecision. Yesterday bulls showed that they are determined here and a few points favor the bullish case here.

First, the QQQQ has drifted above resistance. We cannot call this move a breakout as volume was average and breadth on the overall market was slightly negative. Nevertheless, at points of indecision, price is the most important and price is winning here.

Secondly, the semiconductors followed through on its breakout and made a strong move higher yesterday. If the market is going to rally higher we want to see tech leading the way. And tech can’t lead the way very long if the semiconductors don’t come along for the ride. This was the problem with the rally, which started late last summer. Everything but the semis moved up keeping the rally relatively mild.

Finally, no one trusts the market here. Far more puts were purchased over calls again yesterday. This has been an ongoing situation ever since the market crashed late February. And the result of it has been a market that has been walking up a wall of worry as shorts are forced to cover at higher and higher prices.

Bottom line, the bulls still have some work to do, but they have the wind at their backs here.

Conflicting Data

The market stall at these levels, which represents indecision in the market, can be summed up in three words: conflicting data points.

Money supply has been increasing significantly leaving the market flush with liquidity. This is a positive for stocks. Yet, the market does not price stocks based on today, but on their perceived future value. In other words, the market discounts the future. Taking this into consideration, the market is concerned with inflationary pressures.

Put succinctly, as the Fed pumps cash into the economy there is more to liquidity that can be used to buy stocks. At the same time, this liquidity is sure to cause inflation, which the market will want to discount.

A conundrum.

It’s best to follow price when the data contradicts. Right now the Nasdaq is trading at resistance. The S&P is above long term resistance, but price patterns are not encouraging as the index is trading in a rising wedge pattern and sputtered yesterday.

Meanwhile, the semiconductors have broken out and are pulling back only on light volume (bullish), and, scans continue to show decent set ups. Does this mean that we will see an upside breakout in the tech sector? It’s possible, but chances for a pullback are about equal here.

We aren’t altogether sure that anyone is altogether sure here, which explains why the market isn’t really going anywhere over right here.

No Time to Second Guess

Longs extended their rally late last week overcoming some rather large hurdles, not the least of which was another hit on the Chinese market. This time the US markets ignored the Asian scare.

Options expiration may have helped the rally last longer and we are quite likely to see the enthusiasm wane a bit this week. However, and it’s a big however. We are finding good stock set ups here. When we find good set ups, we don’t second guess the market. At least not when the set ups are very good. We found a handful of very good set ups over the weekend.

Was China a non Event this Time?

Yesterday the US markets averted a crash. The Chinese bump in the road thus far appears to be a non event this time around.

Have traders learned their lesson as they note that last February's crash was followed up buy steady buying? Or, could the answer be a bit more sinister? That is, could expiration day have prices pinned?

We won't know until next week, but we suspect there is a good chance that prices are indeed pinned. Options sellers have a great deal to lose today if the market takes a dump, so perhaps they used some resources yesterday to buy the dip, which in turn caused the crowd to follow.

It's a fine sounding conspiracy anyway.

Yesterday's positive day was the second positive day in a row where indices were positive and market breadth was severely negative. This is a warning that this market doesn't have much of a floor under it.

When markets move up on terrible volume and decreasing breadth, these are warning signs that should well be heeded.

Get Ready for a Bumpy Ride

Any analysis of yesterday's trading is now meaningless. Major Japanese indices are off over 2% as we write.

This is another major sell off in the Eastern markets and it is very likely to once again carry over to US markets. With the US markets at resistance, there is no reason why we can't see another sell off like the one which occured on February 27.

We urge everyone to really tighten up the stops and forget about buying weakness today. In fact, you might use early hope to sell into as the day could turn into a really bloody conflict.

Upside Limited Here

On Monday those who shorted too early were forced to cover, which added more upside. Yesterday we saw the upside extend in the morning, but later in the day short positions were put back on. We would not consider the put:call ratio to be overly bearish however.

Right now the QQQQ is trading very close to the upper end of its trading range. We expect to see a bit more upside here as it moves into resistance near its last high in the $45.50 area. The potential for a breakout at this point does not appear to be strong though. Price and volume just do not support a breakout move here and unless we can get some really great earnings in the next week or two, we should see this index bounce off resistance for the 5th time in so many months.

Dangerous Territory

Would you buy this stock here?



The chart above is the QQQQ. As you can see it is fast approaching the resistance area where it has already suffered 2 very harsh corrections. Yesterday’s volume as it moved up to fill the gap was just over ½ normal volume levels.

We don’t know about everyone else, but this does not inspire us to buy shares at these prices.

To make matters worse, the put:call ratio flipped back to more bulls than bears. The market isn’t overly bullish here, but the fact that the crowd is now starting to believe in this rally, which they have up until now doubted, also does not inspire confidence from us.

We wouldn’t short yet, but if the market continues higher today on light volume, we will certainly want to put on some short hedge positions by tomorrow.

It's Hard to Trust the Market Here

The market is dull here. There's an old rule that says never short a dull market. Many times that is good advice. At the same time, it's difficult to get too long in a dull market as well.

The QQQQ is trading just below the gap opened on February 27 and there seems to be a better than even chance that that gap will be filled this week. What happens after that is difficult to tell.

Essentially, it is a good idea to take only those trades on stocks that are showing something unusual or extraordinary this week. Be really, really picky in this environment. Traditional set ups are not very compelling in a market that is trading much closer to neutral than it is to either a bearish or bullish bias. For just as easily as we could get a gap fill, we could also see another negative week that takes us back near the bottom of the market's range.

In the case of the QQQQ, that would be back to $44. In fact, we would give the odds of a gap fill or a move back to $44 about a 55%-45% chance respectively. These aren't very good probabilities on either side of the trade.

Feeling Lucky?

We hope no one is superstitious, because yesterday was the unlucky day; if you were heavily short that is.

What can be learned about yesterday’s market strength?

1. That calling a top in a bull market is foolhardy. 2. It doesn’t pay to follow the crowd when the trend isn’t strong.

When the majority of the analysts are looking for a pullback and when the put:call ratio is overly bearish (2:1 puts to calls is overly bearish), then the market is going to do some damage to the crowd’s trading accounts.

This is what occurred yesterday.

What does yesterday’s rally show us about the future direction of the market? Probably nothing. From here the market is going to be driven by earnings season. It’s still way too early to know how the market is going to embrace this quarters round of earnings. As such, we don’t have a bias right now. We will take the trades as they come, but will not be aggressive again until a clear trend resumes.

Risk:Reward Not Favorable Here

We are at an interesting juncture today. Indices and stocks alike sold off on higher than usual volume yesterday, indicating that we may be due for a retest of the March lows. Technically this is what the daily charts are telling us.

At the same time, we can’t find an analyst out there that doesn’t see and think the same thing. Everyone is looking for a pullback here; everyone. And the put:call ratio on several important index contracts has continued one of the longest bearish streaks we have witnessed in years.

Even so, we were ready to hedge today and buy the SDS, an exchange traded fund (ETF) that moves up when the S&P 500 moves down. It makes sense. If you look at the SPY, it is at resistance and yesterday it was rejected on higher than average volume. Meanwhile, the SDS saw a volume spike as it trades near support. It’s kind of a no-brainer trade, so why don’t we take it?

Well, we may be over thinking things a bit much here and if so, we will have to live with missing out on some profits. But it really sticks in our craw that everyone is expecting the same thing to happen; a price tumble. If there is anything we hate, its agreement with the crowd at turning points. We don’t mind being in agreement with everyone when a strong trend is in place. In those situations the market is bigger than contrarian sentiment readings and the sentiment of the crowd drives the price. When the trend is not strong though, the market does a great job at fooling the largest number of people.

The trend is not strong here, so we are admittedly nervous about jumping on the shorting bandwagon. And once again, we may be wrong and the crowd may be right and we may miss a profit opportunity. We would rather miss out on profits though than make a bet we are uncomfortable with and end up losing money. We are funny that way.

What really helped us decide to head for the sidelines today though was our analysis of the SDS chart on the intraday view. You see, we have a rule about stocks we trade. They need to look good on all levels. We want to see a good chart on the weekly view, the daily view, and then the intraday view had better confirm, or we won’t take the trade.

Well, that’s what happened. We pulled up the intraday view on the SDS, and frankly, we just wouldn’t buy it here. Volume was barely above normal and indicators, instead of being oversold and turning up, are actually overbought and turning down. This is a bad bet in our books.

It doesn’t mean, mind you, that the market is going to power up through resistance in the next few days. The market will probably turn down here. We just think that it’s probably going to have a hard time gaining any traction to the downside and that those who put on short positions are going to be frustrated as prices don’t make much progress.

The SDS has an open gap between $57 and just over $58. We wouldn’t be at all surprised to see the S&P turn down and the SDS turn up to fill that gap. That’s what? A 2% gain on the SDS, or a 1% move on the SPY. That’s not a good risk:reward ratio by anybody’s calculation.

Gold May Break Out

The gold sector has an interesting development here, which could potentially lead to a multi year move higher.



Note the weekly view on the XAU index (the gold bugs, HUI index is very similar, if not slightly better). Since August of last year, the gold index has been bumping up against the resistance line we drew on the chart above. Technicals have been improving dramatically on this last run up to resistance and we believe that the index is on the verge of a huge breakout here. A break above this line should give gold shares a huge lift and cause stocks in the sector to complete the second leg of the measured move pattern.

In plain English, it is reasonable to expect a move equal in length and time to the run in gold which took place in the years 2005 and 2006.

Buying Opportunity Likely this Week

Asian stocks are pulling back today and the US indices and most stocks are in overbought territory. It is likely that we will see a pullback today.

However, put buyers continue to bet on a large slide here as they poured money into downside bets at more than a 2-1 ratio in both the S&P (OEX) and Nasdaq 100 (NDX) pits. This means that any dips here should quickly find support and that they should be used as buying opportunities, not as reasons to panic and bail on long positions.

Stops on Short Positions May Get Taken This Week

Markets are at resistance and have moved up on light volume. This is not a factor that is going to cause a pullback, but it definitely could be the warning to heed.

Even so, Asian markets are up big today and recently when Asia has been up or down, the US markets have followed. We could see a strong bear busting day today if this trend holds up.

Stocks Firm Up

Major indices lifted up out of there consolidation areas yesterday. We had noted a couple of days ago that they were trading with a series of dojis, indicating a refusal to go lower. Now the double bottom has provided both support and a second price surge.

Indices are now poised to retest recent highs. It’s likely they will considering the number of stop losses placed above by the massive short position that has been undertaken by retail traders over the past few weeks. As those shorts are covered at higher price it may continue to give this market a lift and move it back into the healthy position where it is once again climbing a wall of worry.

We don’t want to make too many predictions about what to expect next though. It’s better to just wait and see at this point. We will note that a number of much better set ups are starting to emerge. They are still few and far between, but the trend shows improvement.

Schedule: The market will be closed on Friday for the holiday weekend. We will take the day off tomorrow as well getting an early start. We hope everyone has a great weekend.

Speculation Drives Commodities

Sentiment was mixed yesterday as traders really don't know which way the market will turn next. This makes sense since it is really at a neutral point here.

Meanwhile, we are seeing signs of speculation in the metals and oils as traders make bets about what will happen next in the Middle East.

Most of the time these types of moves that run on speculation end up being a bit of a pump and dump where a large group ends up as the bag holder. However, it's still early in the game and the pump stage can be quite profitable if you know when to head for the doors.

Market at Support, but Resistance Looms

If you look at the weekly charts here, the market has some potential to pull back down to the March lows, creating a C leg in the A-B-C correction we discussed in detail last month. However, the daily charts disagree.

Generally it is good practice to give the greatest weight to the weekly charts, but since the weekly charts are really not very clear, we don’t have much of an option but to try and decipher from the daily charts what to expect next.

What we have is a double bottom, which was confirmed and then tested on both Thursday and Friday of last week. On both those days major indices closed with a doji at support indicating we should move up from here.

The question is, how far?

Until major indices take out the highs established on March 21, then we consider this to be a ranging market. If and when that high is overcome, then we will be back in an intermediate uptrend. Since the long term trend remains up, we should see some really great set ups emerge at that point.

Until then, prepare for more choppy market action and trade accordingly.