Securities Research Services

Sunday, April 20, 2008

Be Wary Of The Bull Trap

On Friday the market gapped above resistance and out of the trading range it traded in over the past three months. Bulls must be feeling good as stocks have begun behaving quite bullishly over the past week.

We would offer, however, that this breakout may not be the strong bullish signal that so many hope it to be, but rather that probabilities strongly favor the case that it is a bull trap instead.

Let's take a look at a few problems that bulls are faced with here:

1. The long term trend is still down.

This is a bear market and a range breakout does not change this fact. Indeed, we have been looking for the market to return to its falling 50-week average since the market rolled over in January. On Friday the market tagged this average, which virtually coincides with the 200-day average, as seen in the daily SPY chart below.

2. Sentiment has turned bullish near term and traders have changed their bearish views on the long term outlook from bearish to neutral.

With fear out of the equation, and outright bullishness erupting, all the while the price is trading in the vulnerable red zone makes this market ideal for contrarians to open up short positions into the enthusiasm.


The outlook for this market hasn't changed. Ideally prices will continue slightly higher this week allowing prices to drift into the extremes of the red zone to tag the falling trend line. Last week we noted this line was at $141.50, but given the fact that it is indeed falling, we would look for prices to tag the trend at roughly $140.50-$141.00 if overzealous bulls continue to have their way for another day or two.

*Risk of opening new short positions is now decreased and should prices run up to the $140.50-$141.00, an extremely high probability short can be put on.

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