Securities Research Services

Tuesday, July 22, 2008

Indecision Indicates Volatility Ahead

The SPY has rallied into its 20-day average where it has stopped cold over the past two days. Volume has shrunk into the rally and yesterday's meager volume indicates indecision.

Today's scans confirm indecision as good trade set ups are difficult to find and those that do exist look unreliable to us.

In lieu of this situation we have outlined a couple of potential scenarios that could unfold next.

Given shrinking volume into resistance it appears that the near term path of least resistance is back toward last week's lows. Prices certainly could surprise and rally higher here, but probabilities just don’t favor this due to shrinking volume and mixed sentiment readings.

Scenario 1: The first possible scenario to look for would be a decline back to last weeks lows where support at those levels fail and prices continue lower to the $116 target we outlined last week.

Scenario 2: The second potential scenario to watch for would be a low volume retest of the lows, or even the development of a higher low, which then rallies back up again, this time over the falling 20-day average kicking off a bear market rally that could last 6-8 weeks.

Because of the lack of clarity at these levels and the high level of risk, we would recommend either a cash position here, or, if you must, a hedged position where you are equally long the strongest stocks and short the weakest stocks; keeping relatively tight stops on both. In our opinion, cash is the better position until better set ups develop once again; which is likely to occur later this week.

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