Securities Research Services

Wednesday, May 16, 2007

This is What a Top Looks Like

We preach all the time about calling market tops in a bull market. It’s a dangerous undertaking as stocks can continue to extend for much longer than anyone thinks is reasonable. We broke our own rule on this yesterday as we urged everyone to exit their long positions and open up shorts. The warning sign provided by the massive failure of so many good set ups was just too much evidence to ignore.

It now appears that we were correct. If yesterday didn’t mark a market top, then it sure did a good job of fooling us. The Dow made a new all time high, only to reverse mid day and close with a tailing top. It can be seen best on the DIA chart below. Note the tail on the top, which represents a rejection at the overhead resistance line we have drawn.

Volume was heavy on the day as well. Even more compelling is the bearish divergence between the other major indices, and in particular the Nasdaq and Russell 2000, both of which closed on a negative note for the day after failing to rally with the blue chips.

Adding insult to injury, put buying, which had been outstripping call buying on a 2-1 margin for weeks now, evened out to 1-1 yesterday. That the crowd’s overly bearish sentiment turned neutral on the day the Dow reversed mid day from a new all time high is extraordinary. The crowd is not exuberant here, but they are certainly not fearful the way they were up until yesterday.

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