Securities Research Services

Tuesday, May 15, 2007

Quiet Distribution Taking Place

Over the past week and a half we have witnessed the deterioration of great stock set ups. Some we have traded and many more have been on our watch lists. Essentially what is happening is we are seeing the type of stock set ups that work well in strong markets fail to follow through, meeting selling as they attempt to move higher on low volume.

This is typical behavior that precedes a market correction. It’s not easy to see and the good set ups, which appear, serve the purpose of lulling the crowd to sleep as smart money unloads into the rallies. This is why volume is low on up days like yesterday; because smart money is not buying, but is instead selling to the retail investors who are buying in hope of higher prices.

The action is very subtle and takes some time to see it. We have been wary of this behavior over the past week as we have seen some very good set ups fail. The last couple of trading days has now clarified that indeed we are witnessing quiet distribution. We have a rather large watch list, which we have compiled over the past week. Yesterday, more than 90 percent of the stocks on that list, which were looking good on Friday, failed to follow through as sellers picked off the tops.

We are now fairly confident that we are close to a correction. Whether it’s just a quick correction, like the one that occurred on February 27, or a long lasting correction, like the one that occurred during spring of last year we don’t yet know. The market is a flood with liquidity, so depending on whether or not that liquidity is in danger of drying up or not is what is going to drive the post correction market. Right now though, the market is overbought and stocks are vulnerable.

It’s time to use rallies to open up short positions. In fact, it may have been time to do so for the past few days now.

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