Securities Research Services

Thursday, May 17, 2007

A Look at Resistance

The market is giving mixed signals this week. On Tuesday the Dow tailed off at the top on heavy volume. Then yesterday, just as the market threatened to break down, dip buyers came in and bought prices back up again. Tuesday’s sell signal then gave way to a buy signal yesterday.

Does that mean we should run out and buy stocks? Not exactly. If you check the weekly chart on the QQQQ you will notice two things. First it is overbought technically and momentum has faded over the past three weeks. Second, it has been bumping up against the same resistance line that has hemmed in the index for the past 5 years.

This week has been one of the strangest and most confusing weeks we have seen since June of last year. Frankly, we are not sure we can trust any signal that comes out this week since options expire tomorrow. This one day up, one day down action is more than likely due to the fact that prices are locked in near maximum pain levels than it has to do with the typical tug-o-war that takes place at market turns.

Take a look at the weekly view of the QQQQ chart below for a better idea of how important the $47 price level is:

Note that it has been bumping up against resistance at this level for four weeks now. As the price struggles with sellers in the area it has traded in a range between $46-$47 for the past two weeks. This is the same pattern that has preceded past failures, which led to multi week downtrends.

Now, take a look at a broader view:

The chart above shows the QQQQ’s weekly view from 2004 until present. Note that the current price is bumping up against the same resistance area that has held the price in for more than 3 years.

One of two things must necessarily occur here then. Either the price is going to fail one more time, just like it already has so many times over the past 4-5 years, or the price will break out above $47.

A break above $47 would be a very significant event and it would likely lead to a multi year bull market. A failure at this level may just lead to a regrouping and another attempt at a breakout several months down the line.

We, and we are betting no one else, knows whether or not the QQQQ is going to break out here or if it will fail yet one more time. We continue to think that the wisest position to take here is to short as close to resistance as possible and use tight stops in case a breakout does occur. As we have been repeating this week, we have seen a number of trade set ups fail at current levels. If the market were on the verge of a multi year breakout, we would think that there would be a lot of individual stocks leading the way ahead of the indices. This just isn’t the case. Likewise, important technical indicators, including stochastics and MACD are at extreme overbought levels.

None of these things bar a breakout from occurring. Think of indicators as a way to measure probabilities. Indicators are never right 100% of the time, but if an indicator is overbought at resistance (which is the case here) then the probabilities favor a price reversal lower. Does this occur every time? No. Just more times than not.

Bottom line: It is important to not trade aggressive this week. Options expiration is making the daily market readings very difficult to interpret. And, with a major market leading index, QQQQ, bumping up against resistance, decision making becomes even harder.

The best course of action is to short the indices on the rallies and use tight stops. Anything beyond that would be considered gambling. Putting probabilities on your side is very tough right here, so it’s best to be very conservative until this situation resolves itself in either a breakout or a break down.

1 comment:

manojsai said...

Sir,Dow is in a trading range but cubes and spider are yet to achieve that range.The excess of liquidity due to carry trade and falling dollar is driving up the market,more skewed toward heavy cap stocks.Bollinger bands,macd etc are average based and not a replacement for common sense..