Listening to the Market: Character Change Underway?

It's important to listen to what the market is telling you. We have been analyzing the market under the assumption that a bear market is underway and with that assumption probabilities favored a failure at resistance levels we have been outlining for weeks now.

And indeed, the market may yet fail in this area. But again, listening to what the market is telling us here needs to be factored into the equation.

This week the SPY carved out a head and shoulders topping pattern, but what has not happened yet is confirmation of this pattern. Yesterday, instead of breaking down, which appeared to be a promising scenario, it rallied off of support in what turned out to be a major short squeeze.

Meanwhile, the QQQQ and The IWM, which have been diverging higher against the weaker Dow, S&P and the financials, broke out to multi month highs.

So let's consider this for a moment. The QQQQ breakout came on less volume than previous averages, which makes the breakout questionable. Another way to look at this though is to consider the fact that the NASDAQ is climbing a wall of worry here.

Setting aside the major indices here, which remain somewhat murky with the continued divergences mentioned, what is very clear is the fact that commodities, which have led this market, are in fact climbing that wall of worry.

Oil broke free from its pullback with gusto yesterday and oil stocks squeezed shorts hard. Steel and ag broke out to fresh new highs. And all of this occurred on heavy volume. So while the low volume QQQQ breakout is on shaky ground, the commodity breakout is clearly the real thing.

When the market proves your theories wrong listen to what the market is telling you. Right now the market is telling us that market leadership remains firmly in tact. Ignoring this message would be fighting the tape and as everyone knows, the number one carnal sin of stock trading is fighting the tape.

From the weekly view of the SPY we see that two weeks ago the market gave a strong sell signal as it failed at resistance. Last week it appeared to be kissing the trend goodbye as it moved up on low volume. This week, however, the price has refused to break down and is now in a position to shrug off the sell signal. More importantly, this move has come on heavy volume. If it doesn't break down today we must necessarily begin operating under the assumption that a wall of worry is building and that means that it may be time to cover short positions and start looking for longs amongst the market leaders once again.

Note on Support and Resistance: Resistance is an area, not a rigid line drawn in the sand. Oftentimes stocks will test resistance levels, such as the 50-week average by moving slightly above for a week or two before a failure takes place. We saw such a failure two weeks ago.

What has occurred since, however, may be a sign that the character of the market is once again changing. Over the past two weeks the 50-day average has acted as support rather than resistance. More importantly, it has begun to turn higher after a 6-month downturn. If prices can close near or above yesterday's close today we must begin to assess the 50-week average as the new level of support instead.