S&P Failure Like a Rock Around Market's Neck

Last week we went against the crowd and went long again after making money on our short position HOV. We decided to do so as market sentiment was overly bearish and trading on sentiment has proven to pay off well over the past few months. This time we were wrong.

On Friday the failed breakout on the S&P 500 proved to be a lead weight around the market's neck and stocks sold off heavily. Most of our long positions stopped out.

Sometimes the market catches you unaware. We have been making money on the majority of our trades for two months now, so staying with the uptrend has been the right thing to do. We got caught pushing our luck on Friday, but that's what stops are for.

The alternative would have been to avoid all risk over the past two months and not make any money.

What we want everyone to keep in mind is that timing the market is an imperfect art. No one gets it right every time. You can, however, make money consistently by making sure you lock it up quickly when you find yourself on the wrong side of the tape.

Mixed Market Raises Anxiety Levels

The S&P closed below its 20-day average while the NASDAQ continued to power higher yesterday. Mixed performance in the indices can easily be explained by one word: Banking.

The S&P and Dow are loaded with banking stocks. The NASDAQ does not have much exposure to this very weak sector. What message the weak banking sector is sending about the market's macro issues here is probably not a positive one.

Even so, we continue to find good long side set ups. On top of that, near term sentiment is highly negative. Finally, we are entering one of the most bullish of seasons. Adding up all three of these factors outweighs the negatives for the trader. Let long term investors worry about the economy. Traders should be focused on the tape that is right in front of them.

The Bears Were Wrong; Again

Over the past few days the market has been under selling pressure. The S&P 500, which experienced a weak breakout last week, appeared to have experienced a failed breakout this week. This fact, and the fact that no one believes in the tech rally that just won't quit and oil prices reaching near $90/barrel, has caused a bearish din amongst pundits that is nearly ear-shattering.

A few weeks ago we had this same situation and if you recall we used the bearish sentiment as a reason to get aggressively long. Doing so paid off very nicely.

Over the past two days we got short and tightened up stops on long positions because technically it was the right thing to do. Today, however, it is time to react quickly to this fast moving market, which demands agility to survive, and get long again.

Over the past few weeks we have been developing a list of strong performing stocks to watch. Some of those stocks have underperformed and experienced heavy selling pressure. Some though showed their true colors and their true colors are very bullish. Stocks that didn't succumb to selling this week are set up to rally hard.

We suspect that roasted bear is still on the menu. Don't listen to the noise. The charts and the sentiment readings are telling us that the correction is over.

Mixed Conditions in Front of Earnings Season

The S&P broke its trend line and is very weak here. Transportation is rolling over, which is a warning sign to the Dow theorists, who need transports to confirm the breakout.

Primarily, we take the market's technicals with a grain of salt here. This is earnings season and earnings season is news-driven, not technically driven. It's hard to get serious about the short side in anything but the weak builders and real estate sectors. It's certainly not a time to get aggressively long either.

As earnings roll out over the next few weeks, we should start to get better set ups once again.

Sector Watch: Metals are mixed now with some industrial metal stocks exhibiting strength and others are under severe distribution. Gold looks to be making a dip in an uptrend. Oil stocks are neutral here. China is now under distribution, but we would hesitate to short it as it can be extremely volatile. Shipping stocks, like metal, are mixed.
The stro
ngest opportunities are now on the short side in the builders and real estate sectors.

Trend Watch In Effect

The market is in a very tough spot here. The S&P broke out, but volume was not intense. Yesterday the S&P looked like a breakout failure intraday, but by the close it was able to move back up and close at new support.

It's tempting to join the other pundits and repeat the worn out idea "market participants are not willing to make any bets in front of the slew of earnings," but that may in fact be what we are faced with here.

As a result, no one can really know what to expect next. The uptrend is still in tact. Commodities continue to behave well. The future probably depends on projections that come with all the conference calls in the next few weeks.

As we noted yesterday, avoid everything but Energy, Metals, Asia, and Shipping.

The Right Thing to Do

On Friday, dip buyers kept the trend alive despite Thursday's hard late-day sell off. The S&P closed the week above its breakout, so double-top watch is now off the table and false breakout watch is on the table.

The tech sector is way overbought and is vulnerable for a sharper correction.

The market is getting tricky to navigate after so many weeks in a row without a serious pull back. We would focus primarily on the hot sectors (China, Shipping, Oil, Gold, Metals) and avoid everything else for now.

Oh, and keep tight trailing stops. It's the right thing to do.

Key Reversal Day May Change Market Character

Yesterday the market gapped higher in the morning and the bull trend looked healthy throughout morning trading. However, in late day trading it suffered a key reversal and indices sold off hard on volume.

This potentially marks a character change that needs to be carefully monitored.

Two likely scenarios to follow are:

Bulls refuse to give up the trend and after a shallow dip, prices will move back up to fresh new highs.

Or...

A top of significance was put in and prices will trade sharply lower in coming weeks.

At this point no one knows.

Focus On What's Working in This Market

Are we starting to see a pattern develop here? One day up followed by one day down? The broader market was stuck in the mud yesterday and stocks outside of a few strong areas in tech and the commodities sectors aren't offering up a lot of confidence to buy in at these nosebleed levels.

It's probably best to be really impatient with the market here and just focus your attention on what is working and weed out of your portfolio that which is not.

And We Now Have Follow Through

We got the follow through we had been looking for on the S&P 500. This means that the broader market is just now starting to participate in the tech and commodities rally.

Even so, it is best to focus most of your attention on the high flying commodities here. Oil and metals stocks are just now breaking out of strong chart patterns like cup and handle, double bottom, and inverted head and shoulders.

We would categorize these patterns as longer term breakouts. Pennants and bull flags are short term patterns that project short term moves. Patterns like the cup and handle project multi month, and sometimes multi year moves higher.

We appear to be at the threshold of a major move in commodities.

Lack of Follow Through Concerning

Yesterday's lack of follow through on the S&P is concerning, but it's not a deal breaker. Yet. We need to watch carefully here to see if the bullish trend can reassert itself. Bulls need to step up to the plate and buy here; if they don't the market will be vulnerable for a sharp correction.

S&P Breaks Out

The S&P did indeed break out Friday. Over the next couple of weeks we will be looking for follow through. As long as there are no major fades this week, the bulls are looking at a good fourth quarter.

S&P Coiled and Ready

The S&P has been coiling into a bullish spring near its highs over the past few days.



This is very bullish.

As noted earlier this week, bears are looking to fade the breakout attempt because they believe that a double top is forming. The problem with this strategy is that double tops are very rare and betting on one offers one of the lowest probabilities offered in the market.

Right now the recovery from August lows looks too sharp. As Einstein reminded us, however, everything is relative. It may be a sharp recovery when considered from a smaller time frame. And, were we not in a bull market it would make good sense to argue that prices are destined to return to their mean.

But we are in a bull market. In September 2006 the SPY was set up exactly like it is now. Then, as we suggest will happen now, no double top was to be had. Prices did not regress to their mean, but the bull trend had its way and bears betting on downside contributed to the rally as they were forced to cover at higher prices.

Recent price action would suggest we will see the same thing occur this year.

S&P Watch, Day 2

Once again, it's S&P watch. The market lost some momentum yesterday, and we may see prices remain flat for a few more days.

To our eyes, the S&P looks a lot like Microsoft (MSFT) a year ago September. Keep in mind that double tops are very rare in the market, so it is advisable to bet against them. September 2006, MSFT was faced with a double top. Momentum waned mid month. Then late in the month it powered higher and didn't look back for several months following.

Of course we can't know if the S&P will do the same here, but these types of patterns oftentimes repeat in the market so this idea serves as a bit of a road map to watch for.

S&P Watch

There is not much new that can be said about the market here. Just keep in mind that all eyes are on the S&P here. It is near breakout levels and given strength in the other sectors, it seems likely that it will indeed break out here. Some consolidation first would be welcome, but not absolutely necessary.

Small Caps Starting to Take Over

The new quarter got off to a raging start as bear's arguments for a double top stung them badly. Most impressive here is the rotation into the small cap sector. The Russell 2000 is finally getting some play as money starts to move back into the more speculative stocks again.

There has been in place a flight-to-safety and the small cap index has been lagging. We suspect that the faster moving small cap stocks are going to start offering some excelling opportunities in coming months.

Once again, dips are buying opportunities. Days like yesterday are fun, but they don't offer the best entry opportunities. Weak days, like last Friday, when the bears are roaring and the bulls are biting their nails, are the days to get aggressive with your buying. Embrace the dips, don't fear them.

Trend Still Up

The quarter ended with a bit of a whimper. This has caused all kinds of speculation about double tops and every other sort of fearful and bearish arguments that distrustful commentators can come up with.

Frankly, we think all the noise is nothing but evidence for a wall of worry. The market is clearly in an uptrend. Tech is clearly leading the way higher, the way one would hope a healthy bull market would enjoy. Prices are clearly ready to test overhead highs.

We hate to predict too much about this week's price action. If we had to make a guess though, we would say that given the level of fear and the bearish predictions getting thrown around, that the market may have some games up its sleeve. We can see the potential for a scary shake out this week that quickly whipsaws the shorts yet again.

Dips remain buying opportunities.

Note: Here's a story that's not necessarily related to the market. We find Dr. Pausch's story to be highly moving and it serves as a great reminder that life is truly precious.

A Beloved Professor Delivers The Lecture of a Lifetime

Randy Pausch, a Carnegie Mellon University computer-science professor, was about to give a lecture Tuesday afternoon, but before he said a word, he received a standing ovation from 400 students and colleagues. He motioned to them to sit down. "Make me earn it," he said.

What wisdom would we impart to the world if we knew it was our last chance? For Carnegie Mellon professor Randy Pausch, the question isn't rhetorical -- he's dying of cancer. Jeff Zaslow narrates a video on Prof. Pausch's final lecture. They had come to see him give what was billed as his "last lecture."

Steady as She Goes

Breadth was positive once again yesterday and the Dow and S&P are perking up a little. We are also seeing money rotate into the small caps as speculators are testing the waters once again.

Note: We will take Friday off this week.

The 80/20 Smart Money Rule

Major indices lag tech, which is very strong here. Other areas that are strong are China, India, and energy and manufacturing.

The mixed market, along with headlines on sub prime and other recessionary fears has reduced bullish sentiment to an incredible 25% in this week's Walker Sentiment Report.

This very nearly fits the 20/80 rule, which says when 80% of the crowd is leaning one way, the 20% that stand in opposition are likely represented by smart money. With the crowd selling here and smart money is buying, which way do you think the market is going to go from here?

Buy of the Decade?

Every day we scan the market pundits to get an idea of where the market mood is at. Why so many are bearish when the charts look so good is a real head scratcher to be sure. Nevertheless, the overwhelming level of skiddishness out there combined with a Fed willing to prop up the market and charts that are just screaming buys here, we may be on the edge of a serious sustainable market move higher.

In fact, the stars are lined up to give us another 2003. Long time subscribers know what that means. We made more in 2003 than we have in the years since. Add this up and that means that we could make more in the next 6-12 months than we made in almost five years.

The near term market picture is a bit choppy, but it is likely that the bears are going to get stung again later this week as we get the end of the month buying spree.

Keep it Simple

Breadth was excellent yesterday as the market was able to follow through higher. Especially note worthy is the fact that the lagging small cap sector broke out on volume putting an exclamation point on the response to the Fed surprise liquidity injection.

Even better, the wall of worry remains firmly in tact as twice as many are pouring money into puts as they are calls.

This is a market that shouldn't be overanalyzed. Use the KISS principle here and keep it simple. Buy the dips and protect your gains. Rocket scientists are likely sitting on the sidelines afraid to buy this market.

Note: Since tomorrow is options expiration, we will take the day off. Use the volatility to get a good entry price on positions we recommended this week.

Breakout is the Word for the Day

Everyone had an opinion about what the Fed was going to do yesterday. Now, everyone is going to have an opinion about what the huge rate cut is going to mean to the market.

We will let the charts speak for themselves. Here's a weekly view of the S&P ETF SPY.



Note that the heavy sell off this summer was quickly contained; just as it was last February (the large down draft on the left of the chart. The price then formed a base of support for several months and now yesterday broke out big time.

This indicates to us that we are on the verge of a very big move higher. Add to that the fact that market sentiment levels, as of last week, were printing bearishness that hadn't been seen since the market bottom in 2002.

Unless the market spends the rest of the week selling off and the SPY closes back below its breakout point on Friday, we offer that we are looking at the beginning of a significant market move.

Given the shot in the arm the Fed gave the economy yesterday, we doubt it is going to whipsaw lower here. At least one would hope.

Looking for a Jumpy Market Today

The Fed meets today and the market is looking for a rate cut. The raging debate is how much of a cut will the Fed offer; 1/4 point or 1/2 point.

The $24,000 question is, how will the market react to whatever the Fed does? We don't know and neither does anyone else.

Stocks are set up with a bullish posture. Yesterday no one took a chance as volume was extremely low. Today there will surely be volatility, but we won't really know what the market thinks about the Fed decision for at least another day or two as the market needs time to hash it out.

Bullish Technical Set Up

The market continues to trade in a solid holding pattern in front of tomorrow's Fed meeting. Sentiment levels remain at the overly bearish stage and technically the charts are extremely bullish here.

This is the right combination for a strong move higher into the autumn months.

Of course this could all change if the market doesn't like the Fed's decision. But right now, let's focus on the hand we are dealt and the hand we are dealt is very bullish.

Ignore the Noise

Indices are in a bit of a holding pattern as the market awaits the Fed decision on interest rates. The ongoing debate now is not whether rates will be cut, but by how much. The Fed meets in 4 business days, but there is some potential that rates could be cut earlier.

Another Friday morning surprise? Perhaps Monday morning after an ugly Friday?

Meanwhile, everyone is trying to draw conclusions about what to make from the day-to-day trading action. We doubt very much that anything meaningful can be drawn here. The QQQQ is trading just over its inverted head and shoulders (H&S) pattern, while the Dow, and S&P have yet to break the necklines of their own H&S patterns.

As noted last week, anything that goes on below the neckline area is just market noise and is insignificant in determining what to expect next.

What is most interesting, however, is the fact that so many tech and energy stocks are breaking out to fresh 52-week highs. It's probably best to just forget what the indices and the Fed are doing and just focus on what is working right now.

Right now, there are a group of stocks heading higher, so buy the dips, keep stops tight and don't pay attention to the market noise.

Tech Wall of Worry Building Brick-by-Brick

Despite recent market weakness, the tech sector has continued to climb a wall of worry and has healed its damaged technical conditions.

Dips in this sector are now excellent buying opportunities, but entry points matter in this market that has been so rough on price chasers.

Buyer Strike

Sellers didn't get their follow through yesterday. Even so, the buying was weak and not much can be made of it.

Technical conditions are eroding and the second shoe may in fact be ready to drop. The problem here is that the Fed needs to be added to the equation. All things being equal, we would say this market is in for a hurtin'. The Fed may have something to say about that.

This is why the market is such a mess here. No one wants to bet against the Fed. But even so, the buyers are on strike.

QQQQ $48 is the Tell to Watch For

On Friday the market behaved as if the sky were falling after the jobs report came in with a shocking loss. If the report is correct, and considering the revisions that usually follow these reports there is no guarantee that it is, then the economy is already in a recession.

We frankly don't know, and so it seems neither does the market. The market has been bouncing around in confusion for weeks now. It's very hard to take Friday's downturn seriously considering how many times the market has whipsawed recently.

Currently the S&P and Dow are still trading in inverted head and shoulders patterns. If the prices can break the neckline of these patterns it would send a very bullish message. The NASDAQ has already broken out of this pattern and on Friday the price merely pulled back to test support.

The tell here will be the NASDAQ. If the NASDAQ fails here, then it will be important to get short, because it would signal that the second shoe may be ready to drop.

Friday's trading was just market noise. Nothing important can be derived from it. Right now we need to watch the NASDAQ. If the QQQQ goes back under $48 and doesn't recover before the close, then look out below.

Limbo

We should probably start an S&P watch, because the market pretty much hangs on the balance of the inverted head and shoulders pattern it trades in.

As you can see from the SPY chart below, a break above $150 would break the neckline of the pattern and most likely project the beginning of a strong new multi-month trend higher. You can also see, however, that the price can pull back to $144 and still remain within the pattern.

As such, this market is in limbo until this situation resolves.

Momentum Lacking

Yesterday's pull back from near term overbought levels was predictable. What is not very predictable is what the market really wants to do next. It may be a few more days before it really shows its hand.

Europe and Asia are up as we write this, so yesterday's losses are likely to be regained once again today. We aren't willing to go out on a limb any further than this at this point.

Tech Threatens Old Highs

Volume hasn't been strong recently, but a quick examination of what followed the last few market corrections will show that volume was relatively light at the beginning of the new trends. This is likely due to the fact that doubters persist and refuse to get on board the fresh trend until it becomes readily apparent that indeed the market is in rally mode.

With the tech sector leading the way higher and with the financials continue to show strong accumulation, it's just a matter of time before the S&P breaks the neckline of its inverted head and shoulders pattern and marches back up the hill with tech.

Financials Continue to See Accumulation

Volume should start to pick up this week now that the professional money managers are returning from vacation. The inverted head and shoulders pattern on the S&P has not yet confirmed, but prices are ripe for a wall-of-worry climb if that's what the pros have in mind.

With the NASDAQ taking the lead and moving right back into its broken uptrend last week it's hard to make a strong bearish case on the technicals. In fact, the financial sector, which has been choppy, continues to see strong money flow indicating it remains under accumulation.

This makes sense since the sector collapsed on the unknowns. Now that it is known that the Fed is willing to step in and bolster it, and especially now that Bush has offered up a plan to bail out the banks who were facing a sub prime crisis, it stands to reason that prices will once again seek their averages.

Head and Shoulders Bottom?

The S&P, despite the violent downside moves over the past few weeks, appears to be trading in an inverted head and shoulders pattern.

Indeed, should the market respond favorably to the 10 a.m. Bernanke speech, the neckline of this head and shoulders pattern could be broken to the upside, triggering a strong weekly buy signal.

They say don't fight the Fed and that sentiment seems to be what is going on here over the past two days as buyers have stepped up to the plate. Despite Tuesday's ugly sell off, the market has been marching straight back up the hill, carving out the right shoulder and placing the market in a position to start a fresh leg higher in the secular bull market.

No one knows for sure what Bernanke is going to say today, and no one knows for sure how the market is going to respond. Bulls seem to have a big advantage going into the game today though. Let's see if their advantage remains after today's close.

Things Just Get Silly

Yesterday it was clear from a technical standpoint that the market had rolled over. Major indices had, and still do, strong bearish money flow divergences. Indices had made a series of lower lows and the rollover was one more lower high confirming the downtrend. The only thing missing was volume. But since this is late August it's hard to expect much. Sr. traders are on vacation now after all.

Yesterday's reversal was quite the shocker then. It appears as if this market is entirely random; ran at the whims of the Jr. traders playing with their programs.

It's unclear now who has the upper hand, bulls or bears. Under normal circumstances we would continue to give the nod to the bears, but since the market refuses to play right it's probably next to impossible to guess.

Indices are back up at major overhead resistance. The QQQQ is back kissing its broken trend and the SPY is trading up against its downsloping trend line. Technically the market should turn lower once again. But if the market decides to react positively to the next to sure fact that the Fed is going to lower rates in September, you can throw the technicals out the window because the market is going to do what it's going to do despite what it "should" do.

Market Rolls Over into Intermediate Downtrend

Market technicals spoke loud and clear Monday. Indeed, yesterday the market folded on itself, entering yet another intermediate downtrend. br>
Major indices moved up on light volume last week merely to tag their broken 50-day averages. With yesterday's roll over, a test of August lows is close to a certainty. br>
At this time we will avoid making further predictions about where this market is heading. However, if August lows are penetrated, the broad market will then necessarily be considered to be in a primary downtrend. Whether this will occur or not is hard to say. But right now there is a disconnect in the market as high levels of uncertainty have emerged due to the credit crunch and concern that the Fed is more interested in fighting inflation than keeping the economy out of a recession. br>
When institutional money is uncertain, they sell.

Rally Came on Decreasing Volume

Yesterday we wrote: "Selling short at these levels does not seem offer a great deal of potential."

We need to back track on that statement today.

Yesterday's market breadth was hugely bearish and the number of stocks tagging their 50-day averages from below on rapidly decreasing volume is a strong warning sign that the market's sell off that started late last month is threatening to reassert itself.

We may be second-guessing ourselves here, but the technical conditions of this market are clear. They are signaling a downturn from near current levels.

Shorting this Rally Just Doesn't Feel Right

Last week indices pulled up to resistance areas on light volume. On Friday the S&P, Dow, and NASDAQ all pulled up to their 50-day averages on less than strong volume.

This is a classic short set up.

Even so, something just doesn't quite seem right about shorting here. Firstly, it's the end of the month and typically the end of the month experiences strength due to increased liquidity in the market.

But more than that: Bank stocks continue to see leading money flow divergences, indicating that the sector that leads the market is poised to move higher. Then, if you drill back to the weekly charts, all three averages are exhibiting weekly buy signals.

Finally, and this one is most striking to us, is the fact that none of the ultrashort ETFs (exchange traded funds that move up when the indices move down) look very attractive to buyers here. Sometimes it's easier to see the direction a stock intends to go by flipping the chart over. Looking at the DXD and QID (ultrashorts for the Dow and the NASDAQ 100), it is plain to see that these averages are not good buys at this point and as such, their underlying indices are not good sells.



The bottom line: After last week's run, indices are probably due for some type of pullback or consolidation. We would certainly not buy at these levels. Selling short at these levels does not seem offer a great deal of potential either though. Dips from here are probably buying opportunities.

If we had to make a prediction, we would say that either indices are going to power higher above resistance here, and then pull back and regroup for a buying opportunity. Or, they will suffer a minor pullback, which will then be a buying opportunity.

But let's wait and see.

Mixed Messages with a Technically Bearish Bias

Bearish sentiment readings have now reached lows not achieved since the 2003 bottom. The financials, at least so far this week, have been showing bullish divergences between price and money flow, indicating they are under accumulation.

Even so, technically the market is now at resistance and technical indicators tell us we should look for a pullback or a resumption of the downtrend.

What to make of this?

It’s probably best to pay attention to market technicals here.

Financials Perky

Bearish sentiment continues to rage, though fear levels have come back significantly.

Yesterday we noted that the market could either break higher or pull back into what we argued would be a good, low-risk buying opportunity. Indices may or may not pull back from here, but it looks to us as if shorts are going to continue to be pinned to the wall here, forcing them to cover at higher and higher points.

Significantly, the financial sector is showing a good deal of accumulation at current levels. Stocks with the most exposure to sub prime are still iffy, but other stocks in the sector that were taken down on fears this month are now showing leading bullish divergences with a number of important technical indicators, indicating strong accumulation taking place.

As financials go, so goes the market they say.

Hoping for a Dip

Investor sentiment at Lowrisk.com dropped significantly this week. The number of bulls decreased from 28% last week to only 22% this week. Add to this a continued number of traders buying puts and we have the right combination for a market rally.

Over the past few days the market has come off its lows on decreased volume. This is bearish. So how do we reconcile this bearish technical reading against sentiment levels that indicate we are near a tradable upside rally?

The way we see it, one of two things can occur here. The market can, with a burst of volume, break higher today or tomorrow forcing bears to cover. Or, the market can behave in the way it is technically expected.

Technically, the market should roll over from the resistance levels all major indices are now trading at. We submit that if it does roll over, fear will spike even higher than it already is and the roll over will find a higher low from which to launch a tradable rally.

We hope that the later takes place and that the market pulls back here. Buying at current levels does not offer a good risk:reward. Buying into a fear-inducing dip, on the other hand, offers a very nice risk:reward set up.



Of course we need to mention that there is a third possibility. The market could pull back from current levels and keep on going lower. Given that the Fed has shown itself willing to bail out the banks and considering current levels of fear, probabilities of such are quite low. As such, a dip here should be considered a buying opportunity.

As such, we are symbolically crossing our fingers and hoping for some downside today.

Could Go Either Way Today

Light volume indicates that stocks may be running out of buying interest. Nevertheless, prices remain highly oversold and sentiment remains overtly bearish.

We suspect that even if prices dip back near lows, it will just spark another oversold rally. It is doubtful that the ultimate lows are in, but it is almost equally doubtful that the market is going to be able to take out Thursday's lows before it first rallies and shakes out the bears.

A Bumpy Ride Ahead

We should probably rant about how institutional money and the Fed are in bed together and how the Fed, lender of last resort, is actually babysitter to options sellers, willing to bail them out the first sign they are ready to lose a load of money based on foolish hubris. But what good would that do?

The game is what it is. It is not played fair, nor are all players on an even playing field. Sometimes retail traders get the short end of the stick.

We believe that retail traders have an opportunity to get back at the institutional players here though as this volatility lends to those of us who can switch positions quickly. We can quickly jump back on the long side now that the Fed has shown itself more willing to bail out their friends out of a bad situation. Then, when the market starts to fall under its own weight again, and it will (probably sooner than later) we can jump back on the short side and ride the next wave back down.

Considering the distribution taking place, we are looking for the market to stay bumpy, just like it did in 2000. This gives those of us with flexibility to get in and get out quickly a chance to make some nice profits in coming months.

Support Gives Way

Technical support failed yesterday and the market is likely headed lower. Fear continues to spike and the market is very oversold technically. Nevertheless, these measures are relative.

That is to say, relative to the recent low volatility uptrend experienced over the past few years, fear is extreme and oversold conditions are extreme. This causes traders to look for a bounce. But measured against the 2001-2002 market correction, the numbers aren't quite so extreme. In fact, they are still mild.

Keep in mind that the Fed is going after the credit bubble and in doing so, stock prices are sure to suffer consequences.

In our opinion, this is good healthy behavior. This market was getting to be nearly impossible to trade, but now has a fresh breath of life due to the selling. It takes some adjustments to get used to, but there are some excellent opportunities in this market that just didn't exist over the past few years and certainly not over the past year.

Support or not Support, that is the Question

Yesterday the market tested the very limits of support in the trading range we provided yesterday. The Dow broke through, but it still has uptrend support, which could hem it in for another few days.

Technically the market should bounce here. It's oversold, fear is spiking, and it's at support.

Now, whether or not the market is interested in paying attention to technical support levels or not is another question. We shall see.

Game Plan

Raymond James recently issued a technical report on the market conditions and highlighted an interesting parallel between the current market and 1998. We believe that this has some merit and can provide us with a good road map for where the market might be headed as we move into the fall months.

Friday's liquidity injection was quietly rescinded on Monday, so the bullish case for a short squeeze has pretty much gone up in smoke. This is further evidenced by the fact that bulls ignored their opportunity yesterday and went on a buyers strike letting stocks settle back again on very low volume.

This leads us into the Raymond James report. In this chart they show how in 1998 the S&P 500 broke out of a multi week range, but then failed spectacularly and slid lower on several wide-range sell days. Waves "a" and "b" on the 1998 chart below mirrors the S&P between this May and now.



Following the initial break out failure and slide lower, the market moved into a choppy trading range of what turned out to be the "b" wave of an a-b-c correction. It appears that this "b" wave is where the market is at now.

Given the distribution pressure that persists, we suspect that a move back up to the upper end of the range in the "b" wave (2007 SPY chart below) will produce a high-probability shorting opportunity just like it did in 1998.



Keep in mind that once the c leg of the 1998 correction played out, the market did a double bottom bounce and moved on higher to all time highs. We don't know if this time will be the same or not, but since we have yet to see the enthusiastic euphoria stage of the latest bull market, it may be possible that such a scenario develops again.

Short Squeeze Setting Up?

Friday was a day of whipsaws. The market started out with sellers furiously attacking support levels as the credit crunch affecting the financials produced fears that we were fast approaching a 1987-like crash. By mid morning, however, the Fed stepped in and injected several billion dollars into the economy to calm investor fears and add much-needed liquidity. This caused a quick jump, but sellers were still determined.

Later in the day, however, more money was injected and this time it took hold, pushing index prices and financial stocks higher into the close causing a goal-line stand on the SPY and stemming the outflow on the leading financial sector.

Even so, a huge amount of traders made bets on the bearish side last week shorting Friday's bounce. With expiration this week the short positions are the positions most likely to suffer maximum pain. With money stream figures now diverging bullishly in the financial groups, we see a potential for a strong short squeeze.

Keep in mind that this assumes all things remain equal. If another hedge fund crashes this week, shorts may see a breath of new life in their positions.

Selling Just Getting Started

As we had been warning since last week, the recent market bounce was merely a technical one driven by short covering and oversold conditions. Yesterday the real trend reasserted itself with ferocity.

The VIX, what we like to call the fear indicator, has now surpassed two year highs, but rather than signal a bottom we believe this marks the beginning of a much larger sell off. Distribution has been mighty in recent weeks and the credit crunch banks are faced with looks to be the real deal; not just fear mongering.

A look at the monthly Dow chart tells us that this is a market that is in serious trouble. Whatever it turns out to be though, we are thoroughly enjoying this fresh injection of volatility.

Why This Time May be Different

The rally was able to extend another day yesterday. However, the QQQQ has merely been able to move back up to kiss its broken channel, while the SPY has only managed a return to its 50-day average.

We realize that last March the market was able to rally back up into the broken uptrend channels following February's break down event. We believe this time is different though. Ignoring the fundamentals for a moment, since it is possible that the sub prime issue was overdone (we don't think so, but we could be wrong), technical conditions do not favor the bullish case here.

As we noted last month before this correction really got underway, major indices and a large number of stocks, have been under severe distribution ever since the market was able to rally higher from February's drop. In other words, there is evidence that a great deal of institutional selling was taking place into the weak market rally that took place between March and July.

Add to that the fact that the SPY suffered a long term breakout failure in late July; odds are that the rally this week was just an oversold technical rally fueled by a short squeeze. If so, we should see prices start to struggle in their current area.

Technical Bounce Extends

The response to the Fed's status quo statement was met positively yesterday and program trading took the market into positive territory at the close. Breadth is still poor though and all major indices remain below their 20-day averages.

We won't make any predictions today, but will instead sit out the day and watch to see how the market behaves now that the Fed has spoken.

The intermediate market trend remains down, so we are looking for prices to reverse again once this oversold bounce is played out.

Another Turnaround Tuesday?

The market was technically oversold after last week's hard sell off, so Monday's bounce was not surprising. Breadth on the bounce was lousy, however, as less than 50% of the NASDAQ bounced with the index and just over half the stocks in the other two major exchanges managed a positive day.

Many in the market are hoping for a Fed bail out this week. Such hope is not the best platform to base your bullish bets on. In fact, it's a good contrarian indicator that the market has more downside to go. Wishful thinking is always strongest when players are losing money as their positions continue to erode lower.

Could turnaround Tuesday rear its ugly head again today?

The Worst Storm in 22 Years? Maybe

Friday, the CEO of Bear Sterns, noted that his sector (which is a market leader by the way) was weathering the worst storm in 22 years. That's a bold and significant statement.

Indeed, stocks took a dump on Friday and the intermediate trend of the market is now in a heavy swoon.

We are embracing this downturn. Stocks have been under heavy distribution for months now. In fact, the market has been under steady distribution for the past two years, which explains why it has been progressively harder to make money buying stocks. This sell off, whatever it turns into, is something the market really needed in order to reset the stage for better trading.

As we mentioned last week, we don't believe we are now entering a bear market. We may see bearish conditions for a while, but the long term bull has yet to reach its final stage. This sell off may be just the ticket that kicks off that final euphoric stage. We don't know.

Right now what we know is it's best to position for lower prices and when we start to see capitulation and money flows start to diverge higher as stocks inch lower, then, and only then is it time to start thinking of buying again. Right now sell is the only game in town.

Neutral Set Up in Front of Today's Jobs Report

The market is doing a pretty good impression of a market that wants to quickly recoup last week's losses. The reaction to the jobs report today will be telling. The major indices pulled up to resistance on decreasing volume yesterday, but if the buy programs kick in in response to the jobs report, that won't matter.

Be ready for anything today.

Oversold Condition Likely to Get Some Relief

Yesterday's late day bounce was impressive. The SPY held support at its 200-day average and volume on the intraday reversal was heavy.

The question is, is it enough? V-bottom reversals are rare and it is highly unlikely that prices will now climb right back up the hill from whence they started. A recovery from last week's onslaught is certainly possible, but probabilities favor at least another test of the lows.

Today should be a positive as this oversold market needs a chance to catch back up with its falling 20-day averages. We won't have any real answers about this market until we see how it behaves when it retests the lows after the coming bounce.

End of the Bull?

Monday's rally failed quickly and the dead cat could barely muster a bounce. The 50-day average on the QQQQ provided only a temporary pause on the way down and yesterday the index cut through this level in late day trading like a hot knife through butter.

This correction has legs and it is likely to give us some great short profits.

That out of the way, let's consider the longer term prospects of this market. Is the bull dead? If you pay attention to the news you might think so. Sub prime this, bubble that. The problem is bulls don't die on sour notes. Has it been so long since 2000 that we all forgot the euphoria that the last bull died on?

No, bull markets play out in three phases (click link for source):

• Bull markets commence with reviving confidence as business conditions improve.
• Prices rise as the market responds to improved earnings
• Rampant speculation dominates the market and price advances are based on hopes and expectations rather than actual results.

So far the market has experienced the first two, but has not yet seen the third part play out. In fact, as we have noted here repeatedly, bearish bets have been extreme for months now. What's to happen if this correction doesn't in fact turn into something worse, but instead quickly bottoms and starts to run at the highs?

We'll tell you what will happen. All those hedge funds holding heavy short positions will be in danger of underperforming on the year and they will not only be forced to cover, but buy as well if they expect to keep their jobs when the dust has settled January 01. This is how fall rallies get underway.

Hear this and heed the message: If there is one thing you can be sure about besides death and taxes, it's that the institutions that need buyers at the top and sellers at the bottom will not ring a bell and shout that the sky is falling when the market is topping. Just read the headlines in any financial rag right now and ask yourself what mood the media is attempting to engender in the retail market. It's certainly not one of high expectations now is it?

Selling Pressure Persists

Despite the oversold condition of the market on Friday, stocks and indices alike continued to bleed lower and closed poorly on the day. The QQQQ closed at its 50-day average and the SPY closed at its 200-day average, so both are likely to bounce.

Nevertheless, we would not be looking for more than a bounce of the dead cat variety. Last week we noted that we were unable to find anything worth buying despite heavy scanning. Over the weekend we scanned even more thoroughly expecting to find some bounce plays. Instead what we found were a plethora of short set ups.

Lately the indices have not been reflective of underlying stocks. As index prices moved higher, individual stocks were performing poorly. Breakouts were failing and stock prices behaved as if they were stuck in the mud. Once the index prices finally let go last week, stocks finally blew through support levels and sold off with gusto.

We would expect then, that even if we get a weak bounce on the indices this week, that we may in fact see stocks continue to test their supports in a distributive fashion. The number of stocks that are setting up to go lower indicates this.

Capitulation, or just a Breather?

Yesterday the VIX, the indicator which measures investor fear, spiked up to levels not seen since May of 2006. The spike in that case led to a bounce, but it was more of the dead cat variety.

Selling is as brutal as we have seen. The breadth levels on the NYSE were as low as 92% negative yesterday, indicating that 92% of all stocks on the exchange were down on the day. Breadth levels like this typically form at capitulation.

That said, it is still not clear whether the smart move is to buy aggressively. There was a bit of buying at the close, so we may indeed be on the verge of a nice tradable bounce. We need to see what type of mood the market is in today to be sure though.

Distribution Evident

There are a couple of important cross currents at work in the market here that need to be watched carefully. First, we are nearing the end of the month, where funds tend to put extra cash to work. Fear levels are still high, but the trend is reversing and oversold levels are being alleviated and fear is dissipating.

Meanwhile, the technical damage incurred after the large amount of distribution this week has not been repaired. This is best seen by comparing the SPY with its counterpart SDS. Remember, the SPY is an ETF that moves up when the S&P 500 moves up. The SDS, on the other hand, moves up when the S&P 500 moves down. Let's take a look.

Notice how money flow (pink) has diverged sharply lower even as the SPY has attempted to break out over the past few weeks.



Contrast this with the SDS where you can see that money flow has actually diverged sharply higher as the price refused to break down.



Due to these developments, we would be very cautious about buying stocks at these levels. The end of the month buying may indeed only serve to alleviate further the fear and oversold technical conditions that are keeping the market afloat. With this type of distribution taking place, the potential for the next shoe to drop late next week is high.

Major Technical Damage Incurred

Yesterday afternoon was a route. Sellers took over with volume and breadth levels that showed an intensity unlike anything we have seen in a long while. Recently we have been maintaining a bullish posture for two primary reasons. First, sentiment readings and the put/call ratio have been overly bearish. Second, the trend was up.

Let's take a look at where things stand after yesterday's onslaught.

Options traders are extremely bearish and have been buying puts furiously. Likewise, the VIX (which measures investor fear) spiked up to levels not seen since the market corrected last February and then rallied on up to fresh new highs. These are two bullish implications.

Nevertheless, there are some bearish implications that are compelling here. First price: prices on the major indices and on the majority of stocks cut through some important technical levels yesterday and not only did the near term trend turn down, but so did the sub-intermediate. Major technical damage was incurred on high volume yesterday.

Adding insult to injury, most averages and stocks are not yet technically oversold.

Also worrisome is the fact that we are seeing a number of commentators looking for a contrarian bottom to develop. Let's consider this. As noted, the VIX is at levels of fear not seen since the market made a major bottom and then rallied last March. But let's look back a little further to last year. In 2006 the market cracked in early May and by the end of the month VIX levels were spiking up to the level it is trading at today ($18-$19). The market did indeed bounce, but the bounce was merely of the dead cat variety. Before all was said and done, the market went on to fall for another two months and VIX levels moved all the way up past $23 before a major market low was put in.

The bottom line: With the mixed readings after yesterday's sell off it is important to be careful. The market should find some sort of support after such a strong sell off. A huge amount of technical damage incurred though and it is possible that the market could bounce weakly only to lull investors back toward complacency. Heavy caution is warranted here.

Need We Repeat it?

There remains a great deal of distrust in this market but the fact is, the S&P is basing near multi year highs and the NASDAQ has been consolidating gains over the past few days.

Bearish Sentiment Should Lead to Rally

Options traders shorted the S&P 500 by a 3-1 margin on Friday. They shorted the QQQQ by 9-1. Short positions like this mean that we are close to a rally. Today may see some indecision, but we are looking for the market to find support and move back up early this week.

When so many are betting on downside, the only place the market has to go is up. The trend remains up, so it only makes sense to look for a resumption of the trend. Betting on a top is a fools game that most lose.

Long Term Outlook Strong

For the first time in months we saw the put call ratio on the major indices move up to even. This may mean that the crowd is turning less bearish, but it is also possible that this has to do with reshuffling taking place in preparation for expiration today. Nevertheless, it's a development that needs to be watched closely. The market has moved a long way very quickly and could be due for a brief pull back. If the crowd starts to turn bullish, this could be the trigger the market needs to set up for profit taking.

Despite the overbought condition near term, the long term charts look great. In particular, the NASDAQ has now experienced three solid weeks of follow through after breaking out of its multi year trend channel. It broke out of the channel last April, then spent the next two months consolidating and building a base of support. Now that it has followed through we have a chart set up that could lead to a multi year move higher (with pull backs along the way of course).

We keep hearing commentators talk about how exuberant the crowd is getting. We see no evidence of this. In fact, that so many commentators are warning of over exuberance is an indication that the crowd is still trying to find reasons why this market rally can't be trusted. It is when everyone is wild with enthusiasm and the commentators are all finding bullish reasons why the rally can extend that we need to start getting concerned.

Claims that the crowd is bullish at this point seem disingenuous to us; either that, or they are the fodder of cognitive dissonance.

Shorts Feeling Pain

Yesterday we wrote: "We would look for a weak day sometime this week, probably today. At the same time, we will be looking for dip buyers to step in and frustrate the put buyers who have been making big downside bets."

Indeed this is what we saw. The market opened very weak, but then spent the rest of the day defying traders who have taken on a massive short position as they watched their profits erode. Put options are likely to expire worthless for the most part on Friday. If the pattern continues, they will roll their puts over onto next month, which will only add fuel to the fire for longs if they are again forced to cover their losses at higher and higher prices.

We need to be careful not to read too much into this week's trading. Options expire on Friday, so there are a number of reasons why the charts are more reflective of gaming than they are of true supply and demand. Likewise, earnings season is just getting started and the market is still trying price in the data as it gets fed in day by day. Once the data is in, it takes time to process. As such, making big predictions about price trends seems dubious to us.

That disclaimer out of the way, let's take a look at the S&P 500 as represented by the SPY exchange traded fund (ETF). The SPY is showing some weakness here and we are likely to see a hard sell day soon; perhaps today.



Note the topping tails over the past three days, which represent the fact that the price tried to move higher, but was turned back to the day's lows three days in a row. This shows us that sellers are using the rallies to open short positions and/or to take profit.

The same thing occurred in late May, as seen to the right of the chart, and it culminated into a large sell day.

While a sell day is indeed possible, it is unlikely that sellers will gain any real momentum here. We've been tracking the daily options readings and for months now the short position on the S&P 500 has been running at extremely overly bearish readings.

Before we go further we need to remind everyone of a market truism that has proven itself time and again; the majority of options traders lose money and the majority of the time, options the majority of options traders are wrong. As such, watching the options markets offers a reliable contrarian reading on market sentiment.

So, what we have here then is the S&P struggling with its highs and projecting a downturn. At the same time, we see an overly bearish put to call ratio in the S&P options market. The SPX saw 2.5 puts trade to every 1 call yesterday. 2-1 is widely considered overly bearish. The SPY saw 2 puts trade to every call. And yesterday, as we said, was not an anomaly. This has been going on for months now. And just look how much downside momentum the bears have realized over the past few months.

The bottom line: We would look for a weak day sometime this week, probably today. At the same time, we will be looking for dip buyers to step in and frustrate the put buyers who have been making big downside bets.

Wall of Worry in Tact

Index prices sputtered a bit on Friday, but the weekly close on all fronts was strong. All major indices have broken out of their trading ranges on strong weekly volume. Likewise, the put to call ratios continue to betray a healthy level of distrust. We have yet to find an analyst that trusts this rally. Even so, we are finding a large number of very nice set ups and as such, will maintain our aggressive posture.

We may see prices consolidate and pull back a bit this week, but as long as price and volume stay healthy, dips are buying opportunities.

Breakout

The Dow charged on through to make a fresh new high yesterday. Likewise, the QQQQ, after a slight dip early this week, put it to the put buyers (pun intended) and blew on to new multi year highs.

Incredibly, shorts, who played a large roll in getting this rally off the ground as they covered their puts bought on Tuesday, decided to average up and they bought more short positions yesterday. Put buying was more than 2-1 bearish on the SPY again yesterday.

Won't these guys learn you can't call a top in a bull trend?

Apparently not. Nevertheless, they are contributing to the rally and as long as they continue to try and short strength, strength is going to beget strength as their short positions unravel and force them to cover at higher and higher prices.

Today's scans revealed the best set ups we have seen in months and months. We are finally getting reliable chart patterns. We finally got the signal to get aggressive.

Note: we predicted this breakout on July 02, when examining the longer term market outlook. This is a significant event that should lead to some strong gains this summer.

Rangebound Market

The S&P and Dow have maintained their sell signals even after yesterday's bounce. The QQQQ, on the other hand, has maintained its strong relative strength. We suspect that selling pressures may return today, so it's best not to get aggressive here. If stocks can break out to new highs, then the rules of the game will change. For now though, stocks are range bound and are still trading below resistance.

Short Term Trend Turns Down

The market showed its hand yesterday and indeed, it would have paid to short a dull market this time through. The S&P led the way lower, though put sellers are still in the overly bearish category (perhaps this means the sell off won't gain traction?). The tech sector showed good relative strength against the broader market. If this continues, we should get an excellent buying opportunity in tech in the next few days.

For now though, the market is in a near term downtrend, so it is important to lock in the gains and tighten up stops. The target for the S&P and Dow is now June lows. The NASDAQ, measured by the QQQQ, has support at $48, which may or may not hold, and support at $47, which is quite likely to hold.

Dull Market

We don't have much to go on here. The major indices have moved up significantly in recent days, though it's been tough finding good stock trades that will move up with the indices. The market yesterday was quite dull, and of course you never short a dull market. Weekly charts have the S&P and Dow poised for a breakout. If the broad market does in fact break out to catch up with the NASDAQ, will it then continue higher along a wall of worry, or be used as a selling opportunity? We don't know, but the worry remains high here.

Don't Read Too Much Into This

With institutional traders on vacation volume is extremely low. The major index charts are bullish on the weekly view, but the S&P and Dow are neutral on their daily views. The NASDAQ is bullish on all views and the semiconductors are along for the ride. Beyond this, we don't want to make too much of this week's action. Real world forces return next week and any analysis performed on this low volume market this week is akin to grasping at straws. In other words, it is just a meaningless mental exercise. If you haven't already taken our advice, we suggest taking a long weekend starting today.

Take it Easy

The market should continue its bullish bias the rest of the week. This is not the time to lose your head and chase prices. Light volume rallies are vulnerable to sharp pullbacks that can erode hard earned gains in a short period of time. We wish we had more brilliant wisdom to offer than this today, but sometimes the most obvious, simple analysis is the right one. In this case that is, manage your open positions and take a break along with the institutional traders. Monday a whole new ballgame begins.

4th of July Rally Kicks Off

The 4th of July rally is kicking off, but volume is low indicating a lack of institutional participation. Nevertheless, there are a few opportunities in some of the higher beta stocks.

Tops Aren't Built on Fear

We start off the week faced with an extremely mixed situation. As noted in our last report, the SPY is set up exactly the same way the XLU was on June 01, right before its slide. That is, it made a trend breaking leg down, bounced back up to its falling 20-day average, and then made a sharp leg down during the next week. The SPY, and also the DIA, have both bounced back up to tag their falling 20-day averages in similar fashion. Will they also now slide? That's the big question.

Frankly, we don't have an answer. Sentiment readings tell us that there are too many betting on a slide for it to occur. The S&P (or SPY) have seen consistent overly bearish put:call ratios over recent weeks. In fact, on Friday, the SPY had a ratio of 3-1 and the SPX had a ratio of 2-1. Two to one is considered overly bearish and contrarians start looking for a bounce at that point.

While we don't know what is going to happen, here is what we think will happen:

Take a look at the weekly QQQQ.



The QQQQ has broken out of a large cup and handle formation and has been base building above the breakout for the past 6 weeks.

The SPY broke out in similar fashion last October.



In other words, the QQQQ is now playing catch up with the broader market.

Now, take another look at the two charts. The QQQQ, on top, has trend support at roughly $47. We could potentially see the QQQQ maintain its current trading range for another few weeks as it moves horizontally over to its uptrend line.

The SPY, on the other hand, is further away from its current trend, and has broken its more immediate and sharper uptrend. We could then see the SPY make a minor correction back to the $147 area while the QQQQ trades relatively flat.

The bottom line, we have been reading whispers of a major market top forming, but the long term charts just do not support this at this time. Likewise, overly bearish sentiment does not support this either (remember, market tops are not built out of fear, but on enthusiasm). Most likely, based on the charts, we are looking at another few weeks to flat, to slightly negative trading, followed by a resumption of the major trend.

Mixed Market Follows Fed

The SPY is currently set up exactly the same way the XLU was June 1. Take a quick look at the XLU chart to see what could happen to the S&P 500 next. The QQQQ, on the other hand, has been holding up nicely near its highs. This is quite a divergence.

Whether or not the S&P follows the XLU route lower or not depends on how the market decides to interpret the Fed minutes released yesterday afternoon. If the market concludes that a rate cut is imminent, then no doubt the S&P will shrug off the sell signal and march higher. The high level of put buying seems to indicate that this is what will happen.

Meanwhile, good long side set ups can be found in the Automotive, telecom, and semiconductor sectors if you are picky and choosy about what to buy.

Ballerina Springs to Life

The market rallied hard out of the extreme fear base built over the past few days. The pull back, rather than being technically damaging, was akin to a ballerina who dips before she springs. Now that fear has been released the tone is likely to be set by today's Fed minutes, which are released at 2:15 p.m. ET.

The semiconductors regained leadership yesterday, and this is precisely the type of action tech bulls want to see. Technically the charts look to be in fine shape, especially tech. Unless the Fed springs an unwanted surprise today, we should see this positive bias continue for a few more days.

Note that shorts need roughly 7 days to cover, so if the market moves higher here, we could see an explosive situation on short covering alone.

Fear Levels Spiking

Turnaround Tuesday started off with a gap up, but the market has experienced a change of character over the past few days where instead of buying dips, sellers are jumping on the rallies. The day was negative and the S&P has now firmly broken its trend and rolled over below its 50-day average.

Does that mean we should short here? VIX levels, the indicator which measures fear, are spiking at levels not seen since the market rallied strongly out of the late February sell off. You want to short when the market is complacent, and buy when the market is running scared.

We don't recommend buying just yet. We are near a bottom, but unless you have very deep pockets and can afford to see prices get chewed up a bit more before they bounce, it is best to hold off and be patient.

Meanwhile, we scanned every market sector today and found one reliable trend out of more than 100 sectors. Electric utilities are in a firm downtrend and sellers show no sign of letting up anytime soon. The XLU has tried to bounce from its two year uptrend, but over the past two days sellers have been aggressively chopping off the tops. It looks like there will be continued pressure on interest rates, which in turn will place pressure on the utilities.

Turaround Tuesday Watch, but be Careful

Yesterday’s whipsaw trading was extreme. The market dipped in the morning, recovered on heavy volume as prices pushed up into the green, but then they reversed hard again in the afternoon as buying momentum stalled and selling took over again.

Blame the Yen. The carry trade in the Yen has been driving the liquidity, and/or lack thereof for months now. Yesterday’s market reversals tracked the strength and weakness of the Yen throughout the day.

The big question here is are prices ready to accelerate to the downside, or are sellers running out of momentum. Data indicates the later.

The VIX is now back at the exact same level of fear that preceded the hard reversals higher we witnessed on June 8 and June 13. Put buyers are still investing in higher than 3-1 puts to calls. And, on top of all that, the QQQQ has not broken its trendline and the SPY, while back at its June lows, is exhibiting bullish divergences on several important indicators.

It is certainly possible that downside momentum could accelerate here, but it is historically unlikely. It would be a real coupe if historically unlucky options traders actually hit the jackpot for a change. Especially now that we are nearing the end of the month when mutual funds are flush with cash they need to put to work.

The bottom line here is that the market has failed to gain upside momentum when it had the chance after last Thursday’s goal line stand. This does not mean that the market has to now break down and start a larger correction. Unless and until we see the June lows breached, this market is in the neutral to bullish category. Moreover, with sentiment figures at ultra bearish levels and with indices at support and losing downside momentum, odds favor another turnaround Tuesday today.

One word of caution though, if buyers for some reason fail to move back into the market today and prices weaken beyond June lows, then it is best to quickly close out all long trades and get out of the way. Such a situation could cause a panic situation that leads to a better buying opportunity. Yesterday we mentioned this, if such a panic ensues, we will be looking to buy in hand over fist. But not until the panic has gained some steam.

Market Tops Don't Look Like This

Friday's weak day was a disappointing lack of follow through from Thursday's strong buy signal mentioned in our last report. Nevertheless, the weak, choppy trading seems to have had more to do with the restructuring of the Russell 2000 index than it had to do with supply and demand.

The bullish case is building in the near term. On Friday put buying spiked to 2:1 on the QQQQ and more than 7:1 on the SPY. Moreover, the news for the day focused on sub prime, which we have all gotten an earful about lately. Market tops just don't look like this. The market just doesn't work that way. Market tops occur when there is too much enthusiasm, which indicates that all the good news is already priced in and prices have no where else to go but down.

Market tops do not occur when dumb money has loaded the boat with puts and when commentators focus only on doom and gloom scenarios. The market is perverse. Remember that. Those who control the largest blocks of money need sellers to give them shares when they are buying and as such, the news that gets filtered down to the retail market is designed to create fear. In other words, it’s a game of hard ball.

On Friday major indices closed back at their uptrend support levels. If these support levels break this week, we may see a panic occur, but we submit that that panic will be an opportunity to get in and buy stocks hand over fist.

On the other hand, buying was taking place late Friday and with prices back at support, we may just see prices reverse higher again today. Whichever scenario unfolds, this is not the time to be panicky with your holdings.

A Wild Accumulation Day

Market indices did indeed quickly find support after Wednesday's sell off. Yesterday's report explains why.

After all the distribution days lately, it's interesting to note that yesterday was one of the strongest accumulation days of the year. In fact, it was the strongest accumulation day of the year for the QQQQ, which left a buying tail at its trend line; strong, strong confirmation of the uptrend. And it was one of the top 3 accumulation days for the SPY, which left a similar buying signal at its trend.

It looks like we could get a summer rally.

A Very Important Lesson

Yesterday we saw yet another steep decline following expiration week. We have been bearish on the market for a while now due to the distribution days that have been adding up. Nevertheless, it is important to remain objective here and not let your market bias skew reality.

Reality is that while the market is technically not in very good shape here, there has been an underlying propensity toward dip buying that is not easily seen in the daily charts. Every time the market takes a dive, no matter how shallow, dip buyers have been right there putting a floor under the move keeping prices elevated.

If this were occurring in an environment of exuberance then we would discount the dip buyers as hopeful, yet gullible traders. The truth is though, that this has been one of the most hated market rallies on record. Nobody trusts it and this has been reflected by the fact that the options market has seen a put:call ratio near 2:1 for months now. In other words, everyone is afraid of a decline, so they are hedging against it.

So how to interpret the dip buying in this situation? If the majority of market participants hate the rally and distrust it so much that they are shorting it, then it must mean that dip buyers represent smart money, not hopeful retail traders. And like the old Dean Witter commercial, when smart money talks, the market listens.

Robert Carver explained how this works very nicely. This is a keen observation about how the market works, so pay careful attention. This can earn you a lot of money over the years if you understand it and act on this information (highlights are ours):

As the market falls, more investors get nervous and buy more puts, causing more short-selling of the futures to hedge the new puts and it becomes a waterfall. But, the effect is only temporary. As prices move lower and lower, put holders, who have seen their puts rise in value while their stocks decline, sell their puts and then "return to the scene of the crime" to buy more stocks, which are now on sale. This causes the market to immediately rally back, often to new highs, and leads to short covering in the same derivatives which caused the decline in the first place. Short covering pushes the market higher, creating an equal effect on the upside. Hapless bears who took the initial decline as a sign that the "big crash" had started are then forced by rising prices to buy back their losing positions, pushing the market to new highs. And so it goes .... As long as stockholders are afraid that the market will go down, it can't go down for long. The puts create an "ocean of liquidity" which floats the market. And, as long as investors are buying puts, this self-fulfilling prophecy insures the market against a meltdown.

But, you might say, "What happens when investors stop fearing a decline and forego buying puts?" Ah, grasshopper, therein lies the ultimate top in stocks and the beginning of the next crash.

So what is the lesson for today? Since options traders bought puts at a 2-1 margin yesterday it means that healthy investor fear persists and that this decline is likely to be short lived. When the day comes that options traders start to buy calls on the dips instead of puts, that's when we need to look out below.

Sellers Miss an Opportunity

The market has been correcting in time instead of price. Prior to options expiration, we were not sure we trusted this action as the market could have potentially been held artificially higher in order to put a hurt to the put buyers. Over the past few days, however, we have been seeing expired put contracts being rolled over into next month as sentiment levels refuse to budge from an overly bearish posture.

Overly bearish sentiment creates a paradox in that prices can be held afloat by protective measures the crowd takes to hedge their positions. In other words, all those puts that buyers continue to actively accumulate have the effect of keeping a floor under the market. This allows the market to correct in time (sideways) instead of price (down).

This is a bullish development if it continues.

Even so, the broader market offers few advantages here. Dip buyers who are looking for stocks to move straight up are very likely to be disappointed. Flipping has been the name of the game lately and it looks to remain so for at least another week if we have measured the trend lines correctly.

This does not mean that opportunities don't exist however. The lack of selling pressure has given some more speculative, under-the-radar-screen, small cap stocks a boost. In other words, when the cat is away, the mice will play. So right now, when selling and buying remain muted in the broader market, those stocks not so closely watched are seeing some play.

Expecting the Unexpected

The tech sector is poised to extend its recent break out to new highs. However, the broad market is diverging. Yesterday, TheStreet.com's Dynamic Trading System issued a sell signal and the VIX shows that fear that we saw in the market last week has dissipated and that complacency levels have returned. The mixed message the market is sending here raises risk, which has already been very high.

The immediate term path of least resistance in this situation seems to be the downside. At the very least, the market is much more vulnerable for a sharp correction than it is for a sharp upturn. Until the market does something though, it is best to just manage open positions and even perhaps lighten up on some of your positions.

One potential here would be to see the market pull back near recent lows setting up another dip buying opportunity for perhaps a significant run higher. If the QQQQ can break out and close above $48, however, we may instead see the market being pulled higher instead of tech being pulled down. Again, the message is very mixed here.

In any case, today is turnaround Tuesday, so expect the unexpected.

S&P Holds Back Bulls

Last week the market whipsawed bears and put a squeeze to their positions as options expiration games, a focus on inflation numbers, and overly bearish sentiment gave bulls a boost. On Friday the QQQQ broke out to a new high giving bulls another boost.

It's pretty hard to trust the market here, however. While calling a top is a very difficult endeavor, it's not so difficult to see that buying in at these levels is very risky indeed. While the tech heavy QQQQ broke out Friday, it wasn't able to do much more than close unchanged on the day. Moreover, volume was at its weakest levels in three days and certainly not indicative of the type of volume you would want to see as an index breaks out to a fresh high.

Adding insult to injury, the SPY not only did not make a new high, but turned around and reversed hard mid day carving out what is now very likely a lower high, or at least something very close to one.

Traditionally options expiration strength tends to unravel on the following Monday. So, we will be looking for the market to put on a bearish trend either today or tomorrow.

Volitile Week Punctuated by Options Expiration

The market does a good job at frustrating the most people most of the time. Lately, this includes everyone who has longer than a trading strategy with a time frame longer than one day.

This week has seen the market make a hard whip saw, which is fine, the market sometimes does lean hard one way only to reverse and stop out traders. Oftentimes these types of turn around events are good buy signals.

The trouble here, is that this current buy signal is just so hard to trust. The market seems to get rocked by one piece of data one day, only to react equally as violently to a seemingly contradictory piece of data the next day. It's a market that can't make up its mind. Moreover, it's very hard to overlook the fact that indices are very extended and the heavy distribution days we have experienced of late.

In fact, the rally over the past two days looks to us to be a selling opportunity for smart money, or a distribution rally. And, since today is options expiration day, it's possible that the rally over the past two days served merely as a chance for options sellers to collect their fees on all the put contracts they sold last week when the market was in a panic slide.

We continue to believe that the short side offers the path of least resistance in the intermediate term. Near term, however, things are just not very clear. Timing is everything and it's difficult to say when sellers will take control of the market again. The best thing to do when the picture is so unclear is to lighten up the load and raise some cash. To be sure, we will be happy to put this options week behind us.

Whipsaws and Chop

Over the past week stocks have been falling in response to the bond market. Just as the major indices were about to follow through out of a lower high, however, the Beige Book release yesterday sparked a rally as it indicated that the Fed has indeed engineered a goldilocks scenario. One trader noted, however:

Since the Beige Book was prepared there has been worsening news on the housing and real estate fronts. The Beige Book was based upon information collected before June 4, so it does not include data since then, and does not include the observations made by Bernanke in his June 5 speech. So, in other words, the market rallied under a premise that is not backed up in fact.

Today the PPI report comes out, so the market has even more data to digest. Right now the market is getting tossed around like a rag doll as it tries to find its way.

We have a difficult time believing that the serious weakness we witnessed last week and all those distribution days (including yesterday's) can so easily be shaken off. Bonds are still the main driver of stocks in this market and right now bonds are consolidating within an established downtrend.

It looks like the chop is going to stay nasty until the bond trend reasserts itself though.

Market Correction Probabilities Increase

There has been a lot of chatter this week about the similarities between the current market set up and the technical conditions that existed back in 1987 before the crash. Before we look at the similarities, we would point out that there are now measures of protection in place that should keep the market from suffering a similar fate. One reason the market crashed so hard in 1987 was due to the fact that the NASDAQ system was still in its developing stages and could not handle the order flow. Once the sell orders started to hit, they jammed up the system and panic ensued.

That said, similarities are eerie. The set up back in 1987 was a sharp market rally, followed by a steep pullback, that then recovered weakly only to make a nominal new high. Once the weak recovery played out, there was a huge air pocket below that did not lend support during the sell off.



Now take a look at the current NASDAQ chart. It to rallied sharply, suffered a hard correction, and has since moved up weakly only to make a nominal new high.



Note that this last leg higher where the nominal new high was achieved also occurred as money flow was negatively diverging against the uptrend. This indicates that smart money has been selling into the rally.

We have complained recently about how long positions have been stuck in the mud and that they have been prone to stop out failure due to the underlying distribution taking place. In fact, we have taken measures in recent weeks to close out all long positions and to start opening short positions as the market has stalled out.

Clearly the set up is the same now as it was in 1987. This does not mean that the market is doomed to suffer a similar crash. It is interesting to note though, we went back over the index charts over the years and every single time the market has set up like this, it has corrected. Most corrections just took more time to play out than the 1987 correction.

An important point to focus on: One last point to keep in mind, each one of these corrections led to an excellent buying opportunity. Most of which were followed by multi year runs higher. As such, we embrace the opportunities this set up seems to present.

Dead Cat Bounce Pattern

Yesterday we noted the similarities between the way the XLU traded late last month and the way the major market is trading now. Indeed, yesterday the market bounce started Friday stalled as volume decreased. This classic dead cat bounce pattern increases the probabilities of a fresh leg lower.

Will it turn into a waterfall decline? We have no crystal ball to answer that question with. It should turn into a decline, but what type of decline it turns into is anyone's best guess. If the decline back to last week's lows attracts more buyers, then we may reassess our bearish posture. If last week's lows give way to further selling though, then prices will likely decline significantly further.

Lower High Watch Begins

Market corrections tend to play out in phases, frustrating buyers as they drip lower. Last week started out as a waterfall decline, but buyers stepped back in on Friday. This may be the start of the drip lower that will frustrate dip buyers who have been up until now successfully buying dips.

Technical damage was done last week and major indices have seen significant distribution take place. Because of this we will be watching for a lower high to develop this week, which will provide a second chance shorting opportunity.

The XLU, Utilities Spider, offers us a potential road map for the broader market. Note the original slide, similar to that which occurred last week in the broader market, followed by a lower high, which led to a larger sell off last week.



This week we will be watching to see if the broader market follows this XLU pattern. If so, the QQQQ should find resistance at $47.30 and the SPY should find resistance at roughly $152.50. A failure to create a lower high would negate this hypothesis.

A Lot of Fresh Shorting Opportunities Here

We were wrong about the weak bounce occurring. Nevertheless, there are a large number of shorting opportunities still available here. In order to participate, more aggressive entry is necessary.

This market is oversold and will bounce at some point, but the momentum is heavily down here so we may not get a decent bounce for a few more days. Even then, the bounce is likely to be of the dead cat variety. When we do get a dead cat bounce, we can add on to our growing short position.

And the Roller Over has Begun

We have been bearish on the market for a little over 3 weeks now. Three weeks back we closed out all our long positions and took short positions on market indices. Since market tops are generally drawn out processes, it's been tough maintaining our bearish posture at times; especially when the QQQQ index experienced a false breakout last week.

We stuck to our guns though since last week's breakout occurred on low volume and was accompanied by bearish divergences in many of the leading indicators. More importantly, however, the fact that reliable trade set ups had dried up was a huge warning sign that something was just not right.

After yesterday's trading, we are tempted to yell "Vindication!" but it's probably still too early to declare victory just yet. Indeed, yesterday marked yet another important high volume distribution day. More importantly, breadth was extremely negative, with 75% of all stocks in the market in decline.

What this means is, we should now see stocks running into more and more resistance on the bounces that are sure to follow yesterday's decline. A waterfall type move lower is unlikely here, so if that is what you are expecting, you should probably adjust your expectations a bit. Sentiment is highly negative right now, so at a minimum, we are likely to see some of yesterday's short gains being given back.

Summary: Look for the market to drift lower following weak bounces.

Muddy Waters

Rather than clarify things, yesterday's market served to muddy the already murky waters.

As the Yen-carry trade, which has been creating so much liquidity in the market hiccupped at the open, prices sold off on heavy distribution-like volume. This was in fact the type of behavior we have been looking for and had actually predicted would happen in yesterday's report where we called for a turnaround Tuesday.

But then in came the angels to the rescue and the first dip buyers were bolstered by more buying, especially in the Nasdaq 100, and distribution gave way to accumulation. There is no denying that liquidity remains in this market and that someone or some group with a lot of firepower is willing to step in and buy the dips in a significant way.

Technically the day was a distribution day, especially in the S&P and the Dow. All three major indices exhibit hangman patterns, which theoretically represent reversal signals.

However, all hangmen are not the same. Had the market dipped on high volume, but recovered late in the day on weak volume, we would be looking for an extension of declines this week. Instead, heavy selling in the morning was answered with heavy buying in the afternoon.

This overbought market can go either way here. Any prediction bolder than that is not grounded in reality.

Will this Time Really be different?

Market volume was light yesterday, and breadth was flat. Bullish sentiment remains on individual stocks, but overly bearish on the indices. This is the same type of mixed sentiment we have seen for weeks now, so it's not a very good indicator of what to look for today.

After six positive days in a row now, the likelihood of a pullback or a turnaround Tuesday is high today. The question is, will the pullback attract more dip buyers as pullbacks have been doing for months and months now, or will it turn into something more?

We don't know the answer to this question, but signs of a significant market top remain. Will this time really be different? Again, we don't know, but we have our doubts.

Poor Set Ups Support Our Distrust

We continue to find reasons to hate this rally. Primarily the lack of decent set ups despite the fact that indices continue to squeeze short positions. If this market is really going to break higher, we would hope to start seeing good stock set ups. They are few and far between right now, which has in the past been a warning sign that has been very painful to those who ignored it.

It's a Craps Shoot

Earlier this week, Rev Shark of The Street, commented that this rally is the most hated stock rally by traders he has seen in his career. We can certainly understand and agree with his point. Unlike most rallies, this rally has produced very little to trade off. Indices have been inching higher, frustrating shorts and longs alike.

Buying set ups have just not been reliable the way they normally are when indices are on the march. At the same time, those who put on shorts end up getting squeezed after being enticed in by poor performance.

The market has undergone serious high volume distribution in recent weeks, yet prices continue to find dip buyers who have been moving prices back up on light volume. Distribution days favor the bearish case, yet bearish sentiment favors the bullish case.

The difference between the two this week that has caused prices to squeeze short positions can probably be attributed to end of the month mark ups. Next week reality is likely to settle in and either the market will show us that it really is determined to move higher in this "wall of worry" environment, or the distribution top forming will finally take hold.

Right now we continue to find risk on both sides of the trade as high as we have seen.