Happy New Year!

Happy New Year everyone!

Trading should be extremely light today as the session is sandwiched in between a weekend and a holiday. There is little insensitive to show up today, so most will not.

We suggest that subscribers also take the day off, rest up and go out this evening and have a great time ringing in 2008.

Don't Be A Fool

As we approach the end of the year it seems like as good of time as any to review some basic truths about stock trading.

One basic truth is that no one, no matter how smart or experienced, knows what will happen in the future. The best that can be achieved by anyone is a proper understanding of probabilities and proper action based on current probabilities.

Jesse Livermore once noted:

There arc times when one should speculate, and just as surely there are times when one should not speculate. There is a very true adage: "You can beat a horse race, but you can't beat the races." So it is with market operations. There are times when money can be made investing and speculating in stocks, but money cannot consistently be made trading every day or every week during the year. Only the foolhardy will try it. It just is not in the cards and cannot be done.

This is concisely put. In certain market environments probabilities offer better than random tradable advantages and money can be extracted from the market consistently and quite profitably by those who can read the advantages and who use proper risk management tactics.

In other market environments, however, there simply are no tradable advantages and probabilities promise nothing more than random price action. In random trading environments losses are almost guaranteed to occur because trade set ups tend to fail in choppy, random markets.

The current market environment is trendless. In a trendless environment trade set ups will just not behave the same way they will in a trending environment.

It would seem intuitive to look for ranging stocks and play the range in this type of environment, but the problem is, past performance is just not a predictor of future probability in a trendless market, so even ranges tend to be unreliable.

The solution to this problem is discipline. Heed the warning that traders like Livermore offer: " money cannot consistently be made trading every day or every week during the year. Only the foolhardy will try it." Stay sidelined when there are no advantages.

A trend will eventually emerge again and when it does, you will be able to take advantage of it only if you didn't drain your trading account trying to be in the market each and every day.

Focus on Highly Select Areas

Trading is dull and everyone knows, or at least should know that you don't short a dull market. Opportunities on the long side can be found if you focus on the right sectors and a handful of stocks that are catching a bid.

The Rest of the Week Can Go Either Way

Volume on Monday was understandably low given that it was a short session prior to the holiday. Look for volume levels to remain light until next week when the money managers return from their extended holiday.

Meanwhile, bullish sentiment has been spiking to dangerous levels even as prices have been climbing on decreasing volume. This is a warning sign that a near term correction may be coming to clear out the stops.

That said, so far the bulls remain in control of the larger trend. Let's take a look at the QID, which is an ETF that trades counter to the NASDAQ 100-based QQQQ.

Sometimes it helps to turn a chart upside down to better see who is in control of the trend. Looking at the QID is the same as turning the QQQQ upside down.

As you can see, the bulls are clearly in control as sellers of the QID have been active at resistance:



Probabilities then are that the market is slated to go higher in the intermediate term.

The near term (next couple of days) is more questionable, however. With sentiment figures turning overly bullish, we would expect to see overly aggressive longs pay a painful price for their lack of patience. In the weekly chart above the QID can turn either way here. A retest of the falling trend (rising QQQQ trend) is at least as much of a possibility as a break out to the downside (QQQQ breakout).

The message here, stay patient here and only buy pullbacks; don't be a price chaser.

Longer term: When we move into the new year the end of the year mark ups could potentially lead to a broader degree of selling. This market has been horrible for long term investors and the outlook does not promise to get better in the near term. Be highly skeptical of any upside breakouts here, they may in fact just be bull traps.

Strong Rally, But Skepticism Warranted

This rally may be just a late year holiday run. However, looking at the weekly QQQQ chart it looks like this rally could have legs. The real test will be whether it can take out December highs.

It seems likely at this point that it will. Volume may be an issue. It already decreased on Friday. This coming week volume is sure to be low as it always is during the last week of December. This will make it difficult to draw any conclusions about this market.

The last two years the market has rallied into early January and then turned back hard as selling kicked in. This year may be setting up the same scenario, so it is important to be skeptical of any move and to use trailing stops on open positions.

Buy Signal Kicks Off Santa Rally

In yesterday's report we showed how the QQQQ was at a pivotal point of support. It had to either break down or break higher. Whichever way it went, would likely decide the coming trend.

Yesterday it broke firmly higher on strong volume. This offers us a reliable and strong buy signal.

November and most of this month were teaser months. They put the market into a bearish mood and took shares from weak handed players. We don't know if the market can make a strong sustainable move out of this area of consolidation, but so far it looks like the bulls are regaining their leadership.

Changes Are Coming

The market typically moves from periods of inactivity to periods of strong activity. Over the past seven weeks, the market has seen one sharp three day drop followed by a weak, choppy, trendless environment, as can be seen in the QQQQ below.



Unless you were aggressively positioned for a short by bucking the trend and guessing the top in early November, you haven't had a sustainable trend to exploit since October.

Those with crystal balls called every turn in the chart above, but the rest of us have either just stuck to the day trade trends or have seen their positions fail to gain traction as strong moves reverse from day to day.

But the good news here is, as stated above, markets move from periods of inactivity, to periods of strong activity.

The QQQQ is at a pivotal point here. It has trend support at its current level. If it can rally from here and move up to take out December highs, we could get a sustainable trend going again.

If, on the other hand, it breaks down here, we could potentially see a bearish trend develop into the new year. Either way, this period of inactivity is drawing to a close and everyone should look for trading conditions to once again provide a trend that is exploitable.

Sloppy, Sloppy, Sloppy

The indices look to be turning the corner here, but don't be fooled. This masks the fact that the majority of the charts out there are just plain sloppy.

Don't forget that this is options expiration week. We doubt very much that stocks are going to turn around and march back up the slippery slope they have been sliding down. Sellers are likely to play games with any moves higher, so be careful, don't chase prices, keep order sizes small, and look for the one or two obscure stocks that might be bucking the non existent trend.

Turn Coming

Yesterday's selling concluded with a 70-80% down day for all three major exchanges. Sentiment figures spiked to overly bearish levels and twice as many dollars found their way into puts than calls. These types of figures are typical before a market turn.

Add to this the fact that we are near one of the most bullish seasons of the year and it makes sense to start putting together a list of potential short squeeze candidates.

Cash Remains King of the Hill

Running through scans over the weekend we get the impression that there is potential for another panic situation setting up. Sellers are getting pretty desperate in the retail and banking sectors, among others. Very aggressive shorts might work here. If we were in a true bear market it might make sense to get aggressive on the short side here. The problem is, we are not in a true confirmed bear market. In fact, seasonality would indicate that selling is close to exhausted and that we are more likely setting up for a strong reversal to the upside.

We noted last Friday that short positions taken here have great potential for trapping hapless latecomers, squeezing them as this random market suddenly reverses higher again.

This week options expire right in front of the holiday weekend. Games are going to get played. And since the largest number of positions are building up on the short side by those who have aggressively chased prices, it is most likely the short side that is going to feel the greatest amount of pain at some point this week.

We are itchy to put our cash to work, but conditions for doing so today are at least as bad as they were on Friday; and probably worse.

This market will give us something good over the next few days and as we sit in cash on the sidelines, it is our bet that the market is going to give us a really tremendous buying opportunity.

We know it's hard to be patient, but take another day and let others assume the phenomenal levels of risk that continue to build. When the risk takers pay a price for their impatience, then we will be able to step back in and reap the rewards for staying disciplined in a very tough market.

Cash Is A Good Idea Over The Weekend

Market conditions are tough; as tough as we have seen. The battle for the trend continues and trading is extremely choppy and arbitrary.

Stocks appear to be under distribution, but getting aggressively short is not an option yet. Shorts who push their luck are likely to get pinned against the wall in a Santa Rally, which remains a possibility; perhaps a probability.

Meanwhile, long positions are very vulnerable and failure rates on the long side of the trade are at least as likely to fail as they were last month.

So, what to do?

There are some good reliable downtrends that can be shorted. However, it is important to short strength and not weakness. This is a market that makes price chasers pay the price of stopped out trades.

We need to wait until prices come back to us. Yesterday we attempted a couple of shorts, but the prices moved down and not up into our entry areas. It remains highly likely that prices, even if they turn lower today, will be coming back up to areas where short positions can be put on.

Yesterday we closed out the last of our trades. In this market it is healthy to sit out the weekend in cash. Next week is a new ball game and if we wait, we will get the right set ups at the right times.

Primary Bear Market?

Talk about extreme volatility…

What to make of this market? Traders are getting jerked around like rag dolls here. Over the past month we have struggled to gain any kind of traction. In the past when we have struggled like this, hindsight has shown that we were in a downtrending market during the struggle.

Recognizing the trend when the market is in its initial stages of a downswing is one of the most difficult endeavors in the art of market analysis. We admit, we struggle in this area.

What others are saying:

Don Worden wrote in his report today: ” The market demonstrated overwhelming zeal in delivering its message. No hem-hawing around needed! The practical and safe assumption is that we are in a primary bear market."

The Kirk Report: "Be defensive, hold lots of cash, don't be complacent with your longs, protect your assets, and if you're so inclined, look for strength to short."

Alpha Trends: *summarized* There is a huge battle for control of the trend taking place on the S&P 500. $149 on the SPY is the battle ground.

How the fundamentals come into play:

We are not sure we are in a primary bear market as Worden suggests. Brian at Alpha Trends seems to have pinpointed the situation best when he shows that there is a strong battle taking place for control of the trend. Neither side has taken control yet and the reason why is due to the fact that the market is faced with a new fundamental situation.

The 1/4 point rate cut disappointed the market. There is no doubt about that. The market has determined that the credit crisis will not be eased by such a narrow cut in rates and it has projected that it expects a recession. The Fed, however, has offered up a new approach to the situation. Instead of further rate cuts, the Fed is offering to inject liquidity into the market through other means; means that are as yet untested.

The extreme volatility we are seeing may in fact be a jostling from long to short as Kirk suggests. Or, it could be that the market is trying to factor in the unknowns surrounding Fed liquidity injections.

The bottom line:

As of Tuesday's reaction to the Fed, long side trends are in question. We have continued to see some strength in the strongest sectors, such as Ag Chem, but this strength is not very trustworthy at this point.

Meanwhile, the downtrends in home building, transportation, banking, and retail are showing signs of resumption.

This has been one of the hardest markets to trade in recent memory and holiday factors and the battle for control of the trend that is taking place at this moment don't make things any easier.

It's probably best to be sitting with a good amount of cash on the sideline here and put some money to work on the short side in the downtrending sectors on days of strength.

Dip = Buying Opportunity

Over the past week prices have been climbing without pullback. This has been frustrating as a lot of good stocks have been going up without giving an opportunity to enter. It has been important to exercise discipline and refuse to chase the low volume rise.

Now that the market has sold off hard, predictably, after bullish exuberance and silly expectations for another 1/2 point rate cut, the market is giving bulls a second chance to enter the best stocks.

Today is probably a little early to step in and guess where the bottom of the pullback is going to be. Aggressive traders might try, but prudence would suggest standing to the side and looking for some sort of confirmation that support has solidified.

Bearish bias has returned, however, and a Santa rally into the end of the year is sure to cause the bears pain once again. So keep your powder dry here as this dip is the opportunity we have been waiting for.

Fed Fireworks

The Fed meets today and will release their monthly volatility wave on the market at 2:15 p.m. Look for prices to drift on low volume right up until the release. At release time, the usual fireworks will begin as huge bets are made in reaction to what the minutes mean or don't mean.

The focus today will be on language that indicates further rate cuts, or not. Speculation is sure to be rampant and the first move will likely be faded.

This is all just very normal Fed day stuff. Use the dips to buy the strongest stocks, for once the dust settles, the trend should resume.

History Repeats

July and August of this year the market corrected hard back to the long term uptrend that has been in tact over the past 5 or more years. Following the bounce off the uptrend, in September the market had created an inverted head and shoulders pattern on all major indices. Likewise, many stocks that looked set for further declines in August, had by September and October followed the broader market and created their own inverted head and shoulders patterns as well.

The reason? The Fed had stepped in to bail out the banks.

In November bears started to show their teeth once again as the banks pulled the S&P down and took the NASDAQ trend off its rails. This led to a steep decline back to the long term uptrend again.

Now, here we are again. The Fed is stepping back in and the set up is virtually the same. While major indices don't have a head and shoulders pattern to play off here, we are seeing the same sectors that ran hard in October set up with exactly the same patterns now that we are in early December.

History does indeed repeat herself and sector strength is repeating itself here. If you pay attention, you can profit from the repeat.

Big Cap Tech, Chem, and Industrial Metals are all catching a serious bid here.

The run up last week came on decreasing volume, so we should get a dip buying opportunity this week.

Pay Attention To Where Smart Money Is At

After a very tough month of November, bulls are now back in control and the strong sectors that gave us such a great profit this past fall are once again heating up for more gains.

Like this autumn's rally, it is important to be choosy about where to put your money to work. Stocks in the middle are still prone to choppy conditions; especially with the low volume nature that has thus far exemplified this rally.

Making money in the market is counterintuitive to natural logic. Stocks like MOS are overbought, yet this is where the bid is catching all the dips and where funds are putting their money in order to bolster their bottom line as the quarter runs to a close on December 31.

We can take advantage of this situation by paying attention to where institutional money is likely to support these stocks and entering with them in the high flyers. Every market environment has a theme. The theme of this market is to buy high and sell higher in the areas that the institutions are paying the most attention to.

Market Misdirect Sets Up Powerful Buy Signal

The market threw us a curve ball this week as technicals pointed to a breakdown. It can be very frustrating when the market throws a misdirection at you, but it is important to not let that take you out of the game. These types of reversals tend to turn into strong trends in the new direction.

We are already seeing signs of a strong trend developing again. The same old culprits that we profited from so heavily in September and October are once again breaking out to new highs and showing a great deal of momentum building. These include agricultural chemicals and metals and mining.

So yes, yesterday's stop outs were painful. Nevertheless, they free us up to play the true market direction, which revealed itself yesterday. Now we can once again put our money to work in the sectors that have been offering the greatest profits all year. We suspect that this week's losses will be regained quickly.

Don't Get Chopped Up Here

If you don't have anything nice to say, don't say anything at all. This has always been good advice to follow. Likewise, if you don't have anything meaningful to say, ...

The best we can offer today is that market conditions are extremely choppy. There are no good trends to follow and a catalyst to move the market may not occur until next week. It's best to stay patient here and wait for better set ups. Market predictability is an oxymoron in this environment. It is here that trading accounts get chopped up, so it's best to stand aside.

Downtrends Resume

Yesterday we noted that the longer term trend in the Nasdaq sector was still up and that shorting the broader market was not a good idea. Nevertheless, buying the broader market is not a good idea here either.

Meanwhile, we are seeing downtrends in the weakest sectors showing strong signs of exhaustion after last week's bounce. Technical conditions are ripe for a continuation of the downtrends in retail, banking, transportation, and housing.

Weakness Coming, Then Strength

Traders start off the week with few advantages. The market is quite likely to see weakness early this week. Nevertheless, the intermediate bias of the market should now be up due to the fact that the Fed is likely to lower rates yet again.

If you are a daytrader you should probably be putting on short positions over the next few days. If your timeframe is anything longer, then it's probably best to stand aside and wait for the long side to set up again before acting.

Here's why:

Using the QQQQ as our basis, note that the price is near term overbought and that the open gap below is quite vulnerable.



Swing traders might aggressively short today and hold for the gap fill, but the probabilities on the trade are less than strong. Trading rules 101 dictate that you don't trade against the trend. Below we will show how it is quite clear that shorting the market here is trading against the stronger, longer term trend.

Take a look at the QID, the ETF that trades inversely to the QQQQ (when the QQQQ goes down, the QID goes up).



It is clear that the QID is in a long term downtrend, which by default means that the QQQQ is in a long term uptrend.

So, once again, if you wish to be ultra aggressive here, open some shorts here. We believe, however, that any short positions are vulnerable to wide intraday price swings and that the smart money will be waiting to buy the next dip for a rally that is likely to last into the end of the year.