Europe Leads the Way

The broader US market is still churning, but it's time to take another look at Europe and the metals markets. European stocks beaten down after the emerging market crash has now produced a large number of stocks that have just pulled back to their long term up trends. The accumulation apparent in this market is quite strong and the strong European trend should be ready to resume. Gold and other metals have been hit harder than most but the majority of mining stocks showed accumulation even as they retraced as much as 50% of their recent gains. This shows that there is a lot of confidence in this market by smart money who has been using the gold crash to accumulate for their longer term horizons. It's a good idea to start getting aggressive with this sector as it has a lot of promise over the next few years and right now the miners are relatively cheap.

Bond Market Set to Rally

There is some indication that the bond market is close to bottoming and a potential rally could ensue. This would probably give a boost to the weak market giving us a tradable rally. S&P options traders have already become overly bearish, indicating a bottom is near in the big caps. There remains a disconnect with the QQQQ however as options traders are fairly complacent still and betting a little too heavily on the long side. There remains an open gap on the QQQQ at $37.65 so it is likely that we will see one more plunge before a real floor is in place. Hopefully a plunge back to the lows will inspire enough fear and bearishness that real capitulation can take place and we can then finally put this downtrend behind us.

Trend Still Down

$39.00 is the magic number for the QQQQ. This index is still struggling against its downtrend line, established from the drop, which started early May. If it can close near $39.00 then we might have a bottom in place. As of today however the downtrend is clearly locking in stocks and proving an entry point for sellers to reestablish their short positions. After a two-day rally last week, yesterday we saw what should be a resumption of the downtrend. Since the path of least resistance is down, it is best to position for more downside. Projections at this time show a retest of last week's lows and potentially a minimum of one more lower low before we will see significant support start to develop.

Play the Downtrend

The Japanese Central Bank has exerted pressure on the global market draining billions from markets around the world over the past several weeks. These are the realities of the global economy we are now in. It is likely that the US will pressure the Japanese banks and the bleeding will be tightened before the emerging markets are sent into a tail spin toward depression and western markets slump even lower. At this time the shock is serving to cheapen stocks and create a very nice buying opportunity as investors start to throw out everything in fear. Nevertheless, the downtrend we are now firmly in has not yet found a bottom and until it does shorting strength and breakdowns is the way to go. The stall on Friday should mark the spot where the market will once again turn lower. A move higher this week however should not be taken as a bullish sign, but should rather serve as an opportunity to short higher. As we outlined on Friday the market does not have a base of support and the move on Wednesday and Thursday is unsustainable. A move higher would merely take major indices up to the top of their falling Bolinger bands, setting up another waterfall-type leg lower. In essence, a move lower from the current level would actually be a more bullish scenario. Traders became too bullish once again last week and another long failure would very likely create the kind of demoralization that is needed to set the crowd in the right mood for capitulation. With the economy making some real strides over the past few months a move lower is the ideal set up for a very strong move higher, much stronger than that which we have experienced over the last two years. There is a good chance we will see capitulation this month, but again, until we see it, we need to be selling strength. Because we don't know if the market will fall from current levels or go up to test higher resistance first, it is a good idea to scale into trades.

Why We do not Think a Bottom is Yet in Place

The last two days we have seen a rally nearly as striking as the crash we experienced earlier in the week as last Thursday's reversal day didn't stick. Many want this to be a bottom but we believe that it is not for several reasons: 1. Today is quadruple witching expiration day. The QQQQ and SPY price rally over the past two days has simply moved these two ETFs up to their maximum pain prices. This is called "parking the car in the garage" by Wall Street traders. In other words, the prices have simply moved back up to the point where put sellers maximize their profits and where put buyers over the past few weeks have watched all of their profits erode. Coincidence? 2. The put/call ratio on the QQQQ has gone from 4-1 in favor of puts at the beginning of the week (overly bearish) to an overly bullish 2-1 in favor of calls. This wild swing in sentiment from the bear to the bull side by this group of traders who are almost always wrong at the extremes simply indicate that this wild ride we have been on is not yet ready to stabilize. When two calls are purchased for every put the market will usually reverse lower within a day or two. 3. The QQQQ has only rallied back up to tag broken support between $38.50-$39.00. The SPY has only rallied back up to tag its broken 200-day average. These are classic throwback patterns up to resistance. Pros will use these types of throwbacks to put on shorts and to exit longs that they have been burned on. The market may indeed have put in a bottom but the odds are strongly against it. Longs have a lot of proving left to do. Until we see real capitulation and bottom-building activity we have to recognize the fact that the trend of the market is now down. We are looking for a more significant bottom to form later this month. Right now though surprises are most likely to occur in favor of the trend and again traders are too bullish and the trend is down.

Yes it's hard, but now is where the money is made

The market slide we have experienced this week has been brutal. The drop has been so sharp and the slice downward so steady that it has provided virtually no bounces to sell into. A writer from Real Money made this interesting remark yesterday, which sums up perfectly this week's market environment: The action since the first week in May has been some of the most challenging that I've faced during my trading career. What has made it so difficult is that we have had so many days in a row in which things have gone straight down. Typically, when the market starts to break down, I will continually lighten up my holdings on a bounce. Usually the first big technical breach results in a fairly fast oversold bounce. If you are caught with long positions, that is often a very good time to sell down positions. This breakdown has provided few opportunities to escape long positions on strength. We had one bounce that was fairly limited and that was it. You either sold into weakness or suffered some tremendous pain while waiting for a better exit point. My feeling that this breakdown has been unusual in the degree that it has failed to produce any bounce seems to be backed up by James Altucher's QQQQ crash system, which failed for the first time after 61 prior successes. The idea behind this system is that when the QQQQ is more than a certain level below its 10-day moving average, there is a very strong likelihood that it will bounce back up at least temporarily. In this case, it didn't happen, and that has really made this meltdown much more difficult than ones we have suffered in the past. The good news here is that this correction is much more typical of a corrective move in a larger bullish trend than it is the start of a bear market. Bear markets tend to tease and tantalize hopeful bulls as they slip down a path of hope. Bull markets are known for fierce pullbacks and this can certainly be categorized as a fierce pullback. We would like to remind folks here that as tough as this year has been and as tough as the last few weeks have been that it is important to know when to take advantage of the market's opportunities. After the crash in 1987 many investors spent the remainder of the year looking to get out of the market. The crash was just too scary and the feeling of losing money was just too painful. These same folks didn't buy in again until the market was back in the news again in the late 1990s. The problem is that the crash of 1987 spelled opportunity and those who read the writing on the wall got rich by buying when there was blood in the streets. Take Microsoft for example. In 1987 MSFT was trading as high as $128 per share. After the crash in October of that year it traded as low as $37. Those same shares today are worth $3000 each (calculated for the splits). Right now it is time to start searching for the babies that have been thrown out with the bath water. We don't believe the low in the market has yet been put in, but we are close. Gold stocks are one of the babies that have been taken out to the woodshed in this market and we believe that these stocks are cheap at the current price. Remember, it's ok to get out when the market is falling but it is also important to remember to get back in again. Don't wait until the market starts to look good to get back in. You don't need to try and pick the bottom, but you don't want to wait until everything is rosy again either.

We Were Wrong

Last Thursday looked like things had gotten about has bad as they were going to get. We had expected a retest of the bottom this week but what we got yesterday was anything but a mere test. The bottom formed by a high volume reversal – the highest volume reversal mind you – did not even serve as a point of hesitation in the last hour of trading yesterday. The put/call ratio is nearing all time bearish highs and the VIX is breaking out in force. Both of these events predict a turning point in the next day or two. The problem is that momentum in this market has turned into a convoy of sellers as institutions sell down their inventories in front of the CPI and PPI numbers to be released over the next two days. We are concerned that under the right circumstances the market could find an air pocket to the downside that could bring us down to the expected four year cycle low in nearly one fell swoop. Frankly we had been expecting more lows to form, but we had believed that the market would have significantly retraced some of the damage that was done in May. We clearly called a near term bottom too early. At this point, if the CPI and PPI don't cause a waterfall sell off, we are expecting a relief bounce, but this bounce may be an opportunity to exit open positions and put on shorts. A better buying opportunity is near and this sell off actually sets us up for what could be a phenomenal summer rally. For now though our bottom calling is done and we will step back and wait for a better set up.

Correction Probably Over, But Likely to be Tested

We expect to see a bit more weakness over the next week as the market continues to work on a bottoming process. The danger of the market moving much lower than Thursday's low is minimal at best. Don't expect the market to carve out a "V-type" bottom and go straight back up here, but don't look for a breakdown either. Looking at the majority of stocks, which are in trendless conditions right now, we wouldn't be a bit surprised if they manipulated the market back down to Thursday's lows this week to see if they can shake loose a few more shares from the weak hands tree. Keep an eye on the overseas markets this week; especially the British and Australian markets. Both markets are very close to a bottom and any strength in these markets should trigger short covering and will give the bulls back their lost confidence. Meanwhile, try to avoid the broader market and focus on stocks that are trading somewhat independently.

Revisiting 2002

Prior to the open yesterday the outlook looked about as grim as it gets. We were very uncomfortable shorting against both a spiking volatility index (heightened investor fear) and a crowd that was so bearish that they were putting 4 times the amount of money into put options as they were calls. It is just not a good idea to run with the crowd when the crowd is leaning too hard in one direction. As a result we advised that sitting on your hands and not trading yesterday was the best alternative for all but the daytraders. This turned out to be good advice. After a panicky open we saw massive capitulation taking place as investors scrambled to exit their positions and as smart money grabbed up the shares. What is most notable were the market volume levels. The QQQQ had its all-time highest volume day yesterday as it traded an astounding 280 million shares; and this following a 234 million day two weeks ago, its highest volume number ever prior to yesterday. What does this mean? Well, there are some very strong similarities between volume and capitulation action which took place in July of 2002. Note that in July 2002 the VIX was spiking and the market was spiking downward into high volume reversal days. Following the low in July 2002 the market rallied sharply higher and then swooned into another late summer reversal. October of that year however marked a strong reversal that led to a two year rally. We remember this well because money was easy to make in the market during those two years and we made a lot of it. Why do we focus on July 2002 though? Why is it reasonable to expect a similar scenario to play out? Two reasons: First, the four year market cycle. Every four years the market tends to make a significant bottom as the market responds to lagging election year politics and other political and economic factors. More importantly though, four years ago marks the last time we witnessed such a large spike in volatility and market volume. Smart money is now making their bets and they are betting on upside, perhaps significant upside as early as this fall. Expect some nice roller coaster trading over the next few months. We should be able to make money on both the long and short sides as the market roils in a bottom-carving process. Expect yesterday's lows to be retested in the next week or two or three. Bears have not yet fully capitulated – but they will. Be flexible and be willing to switch sides quickly as the market whipsaws from week to week. This will be a fun ride if you ride with it and don't fight against it.

Crash System Fails

RealMoney's James Altucher developed the J Quad Q Crash Trade several years ago. This trade is triggered when the QQQQ takes a crash run like it did last month. What is interesting about this trade set up is the fact that it predicted a tradable bounce an incredible 61 times in a row. Last week the trade triggered again only this time, number 62, it failed for the first time. Yesterday the QQQQ had a great set up. It was oversold and at support. Tuesday saw a late rally ensue and yesterday morning we had follow through. Then Greenspan spoke. For the third day in a row the market has been battered by Fed members and now the former Chairman speaking publicly about inflationary pressures. This is not new information. They are not telling the market anything it didn't already know. Even so, the Fedspeak has worried the market to the point that every buy set up has gotten hammered back. Yesterday's buy set up rejection was the most troubling as it puts support on the QQQQ into serious jeopardy. Let's take a look: Note the rejection, which coincided with Greenspan's comments, as the QQQQ tried to regain the $39-level. The ETF then proceeded to sell off with the market into the close and even closed below the all important last level of support found just above $38.50. Is this a breakdown and a signal to go short? Yes and no. Technically the QQQQ has broken support and the S&P 500 is threatening its 200-day average. The problem with getting aggressively short here however is the fact that this market has been nothing but whipsaws for weeks now. As soon as momentum gathers in one direction it spins on a dime and heads back the other way. The other problem with getting aggressively short here is that this is what the crowd is doing and the crowd is almost never right at market turns. Four put options were purchased for every one call yesterday. The crowd is obviously overly bearish. What do we do in this situation? Sit on our hands and don't trade. This is the only reasonable course of action to take when the signals are so mixed and the advantages are so hidden. The dust will settle and once it does the pathway will become clear once again. Today going long or going short are both crap shoots.

Accumulation at These Levels

We don't know about everyone else, but the last two days have been exhausting for us. Support testing has been ugly this time around. With the Fed Chairman killing the market on Monday and then Fed board members voicing their opinions in public yesterday, selling has been fierce and support levels have been put to serious tests. Nevertheless, indices and stocks alike are showing bullish money flow divergences when compared to last Tuesday's lows. This means that even as hard as this market has been to endure that smart money has been accumulating even as longs capitulate and give up their shares. We believe that despite what the Fed has been saying in public that the end of rate hikes is probably very near. They of course can't show their hands and some might say that they are even bluffing here so we endure huge amounts of volatility in the interim. Today we expect to see higher prices. In the morning however we could see more support testing; it will depend on whether sellers are exhausted or not. If sellers are out of resources then short covering will likely lead to a quick rally higher. If weakness from Asia bleeds over to the open though sellers might find continued reason to stand firm. Again, historically days like yesterday have proven to be buying opportunities. We believe that we will be able to look back next week and see that indeed, it was a great buying opportunity. Right now it is just exhausting though.

Last Tuesday Revisited

There is something familiar about yesterday's market sell off. It seems like we have seen days like this before. Oh yeah, we had a day just like this last Tuesday. What is also like last Tuesday is the inordinate amount of options traders who are betting on further declines. Two put options were purchased for every call. You would think they would have learned a painful lesson by now but they keep coming back for another dose of pain.

The VIX, volatility index, took another jump yesterday as well. The similarities between yesterday and last Tuesday are mirror-like. The similarities between the market's behavior over the last two weeks and the way the market behaved during the last two weeks last October are also mirror-like in their similarities. The QQQQ still has support at $38.50 so unless that level gets taken out we seriously doubt that the shorts will see much momentum develop. In fact, historically days like yesterday have proven to be buying opportunities.

Yesterday the market sold off when the Fed chair Bernanke spoke about inflationary pressures with hawkish tones. Regardless of what the Fed actually does next the chairman must speak with hawkish tones in order to constrain inflation expectations. This is normal in the late stages of a tightening cycle. We would argue that the Fed is very close to taking a break in rate hikes despite what fearful traders thought yesterday afternoon.

Market May be Ready to Reverse - Oil Strengthening

On Friday the crowd reacted favorably to low job numbers in the employment report. This is because they were expecting that low numbers will force the Fed to take a breather on rate hikes. Of course the enthusiasm attracted profit takers and short positions as these buy the news events almost always do. Technically the sell off from the highs left the indices in poor technical shape with the dust settled on the day. The S&P tagged the under belly of its broken trend and sold off and the QQQQ sold off from its falling 20-day average. Momentum left from earlier buying last week however does not yet appear to have abated. We could potentially see higher prices this week but keep in mind that damage has already occurred and that shorts will be looking to build positions into any further rallies. The commodities market on the other hand is once again heating up. Many oil stocks are resuming their trends and gold prices are hammering out support. We are not confident that gold is done with the downside yet, but certainly any further dips in this sector will represent buying opportunities.

Fear is in the Air Putting in a Floor

The VIX, which we have been discussing over the past couple of weeks produced more very interesting and useful information yesterday. After giving back most of its recent gains over the past week, indicating that investor complacency was once again returning, yesterday's sharp market reversal caused the volatility index to make its sharpest reversal ever. The price on the index jumped an incredible 23% in just one day. Consider the fact that this index measures investor fear, we can ascertain that fear levels jumped through the roof yesterday as stock prices gave up most of their recent gains. Moreover, the bearish posture that traders took on yesterday was also reflected in the QQQQ put/call ratio. Options traders, the group that is so often wrong at market turns, bet 4-1 in favor of more downside. Considering the fact that the QQQQ found strong support last Wednesday, add in an overly bearish crowd that is running scared and you have the makings of a bear trap. Our scans today revealed a great deal of very nice short setups and we can certainly empathize with the temptation to short this market. Panning back to the weekly views though we find only very oversold stocks that are at or near support levels. We saw the same view last October right before the market reversed strongly. We will not make a prediction at this point for a market rally like the one that ensued from October's lows, but we will say that shorting this market is very risky. If prices go below last Wednesday's lows and volume picks up on the slide, then we will concede that the crowd got it right this time and that the market is moving from a minor to a much more significant correction. Right here, right now, history tells us that it is unwise to place that bet.

Two Scenarios, Which Will Play Out?

Last week the market bounced off a vastly oversold condition. Breadth was great as nearly everything but the semi conductors went along for the ride. Problematic was the lack of volume on the move. After Wednesday's very strong volume reversal day, Thursday's and then Friday's volume lost momentum and Friday's volume was less than half that of Wednesday's. More troublesome is the fact that indices are now nearing resistance levels. Theoretically a low volume pull back into resistance is an ideal short set up. In this case it may or may not be. Let's take a look at the QQQQ chart. Resistance on the QQQQ is roughly $39.60-$39.75. If the price can overcome this area this week, we should see a retracement back up near the broken 200-day average at $40.50, while the S&P and Dow test broken trend lines. Such a scenario would set up an ideal short and would allow us to keep open longs for a few more days. However, if the QQQQ rolls over at current overhead resistance, we are most likely going to see prices retest support just above $38.50. A roll over from the current level would not be the best short set up since strong support is just below. Instead it would most likely help build a much stronger base of support for a much stronger rally. Such a scenario would set up an ideal long trade. Decreasing volume into resistance last week suggests that we will see a retest of support this week, leading to a much better long set up as we move into the end of the month buying window.

Be Confident Here, Support is Your Friend

Price was good yesterday and breadth figures were great. Volume was wanting though. While we believe that an intermediate bottom is now in place, there is a decent chance that bears will once again give the bulls a scare and take prices back to support once more. If so, these dips should be used as buying opportunities. Be confident here and don't give up shares just above support. Probabilities of the market heading lower than Wednesday's lows before decent gains are made on the upside are very, very small. Keep this in mind if the hedge funds and day traders once again shake the tree here. Note: TMY is trading right at support on its long term up trend. Keep an eye on it here. We would look for it to make a nice reversal to the upside from this level. Today we will stand aside and let it prove itself.

Opportunities Abound

An intermediate bottom should now be firmly in place. Yesterday marked the highest volume trading on the QQQQ and SPY in the history of those indices. Bearish sentiment readings prior to yesterday (a contrarian indicator) were at all time lows, and the VIX continued to spike higher. All of these readings spell "reversal." We have some theories about how this reversal will play out. We should be looking at a nice uptrend that will last over the next two weeks at least. The blue chip indices might even move back up to test their recent highs. However, we believe that sellers will be looking for another opportunity to short once this rally is played out. This we believe spells ongoing opportunity. Consider this. Sentiment readings and market volatility levels are spiking on the bearish side as we trade near a bottom of a corrective move. Once short covering sparks a rally back higher, we would expect that complacency levels will increase and bulls will once again become overly optimistic. A lower high on the Nasdaq at that point however would really take the wind out of their sails and a second frightening leg down should then follow. If it plays out according to our projections, we should see a very nice opportunity to make quick money going up, going down, and then subsequently will find that a serious long term buying opportunity has emerged. This is why we have embraced the breakout in the VIX as a very friendly development.

Shorts are in danger of giving back some of their profits

Bears have continued to remain aggressive even though stocks are at extreme oversold levels. Yesterday's rally was used as an opportunity to open more short positions. Likewise, the options market shows that participants are overly bearish, giving a contrarian buy signal. Think about it like this. When a stock or the market have recently made a strong extended move higher, it is not at all uncommon for traders to become overly bullish, using every dip as a buying opportunity. Bulls enthusiastically buy calls in anticipation of a fleeting upside breakout even when stocks are vastly overbought. This is what has occurred yesterday, only in reverse. Yes it is possible that the bears could get a slight spike lower, but such a spike would only embolden smart money to buy more aggressively. Shorts were right last week. This week they may find that newly opened short positions fuel a rebound rally as they are forced to cover. Today is a good day to be patient. If the market dips temporarily lower, we should see another nice mid day reversal. If the market firms up at the current price, we will have a solid floor to buy from. There should be no reason to exit in panic here, but likewise, there should be no hurry to enter either. A "V" type rally that regains losses in one big burst is very unlikely here so keep your emotions at bay.

More on the VIX

Yesterday we discussed the VIX, market volatility index. If you recall, a decreasing VIX means that market volatility is contracting. Over the past two years market volatility has been decreasing and over the past year volatility levels moved down to early 1994 levels. Consider that the VIX is also a good measure of investor fear. Fear levels have been very low to the point of complacency over the past 12 months. Smart investors take advantage of the inefficiencies created by emotions. Since emotional levels have been at multi decade lows it has been harder and harder to find inefficiencies to exploit. Alas, this week we experienced an overwhelming breakthrough on the VIX. Note the monthly chart view of the Volatility index below: This is good news indeed. The spike represents an injection of fear in the market that has wiped out complacency in a matter of days. We are already seeing new and promising set ups emerge as a result. Today's market: The market is now basing nicely and yesterday traders were even whispering the words "Black Monday." More frightening words were never spoken and this is just the kind of overly bearish positioning that the market needs to put in an immediate bottom. Like a beach ball being held under the water, we should see prices shoot sharply higher in a relief rally that will surely surprise many. We believe that this rally will be tradable, but be ready to quickly switch allegiances once the downside pressure is relieved. This market has not yet created the even better buying opportunity we believe will emerge.

The Pick Up in Volatility is Great News

Over the past year the US dollar has been under increasing pressure and has been losing value against measures such as gold and major foreign currencies. During this time stocks have been essentially trading in a tight trading range and apart from a bit of strength during October and November of last year, volatility levels have been extremely low. We believe that the low volatility and the trading range environment masked a larger correction that had been taking place. Stocks were rising nominally in dollars, but when measured in Euros or in gold the indices have actually been in decline since December. Last week a sharp decline took on momentum unlike anything the market has seen in nearly five years. Expected oversold rallies never developed and selling progressed on heavy volume without relief. During this sharp sell off something interesting happened though, the VIX (a volatility measure) rallied sharply higher. Now, the VIX measure is fairly difficult to understand, but for the purposes of this report, understand that an increase in VIX indicates an increase in market volatility. So, in plain language, what has been happening over the past year is that the market has been in slight decline, but the decline has been masked by a weakening dollar. The combination of this led to very low volatility levels as measured by the VIX, which was also seen clearly by the narrow trading range. Now that the VIX has rallied sharply higher we can confidently say that volatility levels are picking up. In fact, the jump in the VIX has very real similarities to the 1994 market. This is very good news for us. A tight trading range is one of the most difficult market environments to navigate as buy/sell programs round out the extremes stopping rallies before they get started and stopping plunges before they plunge. In this type of environment it becomes ever more difficult to determine what is market noise and what is real demand. Recall what happened as volatility increased during the 1994 market. That year trading opportunities once again improved dramatically and preceded a huge bullish move that lasted over the next five years. We will discuss more of these implications over the next week. Right now, understand that we are now in a much better trading environment than we have been in for quite some time.

Cash is King

Taking the current market conditions and framing them with a historical perspective a relief bounce is overdue. Likewise, using that same historical frame of reference, due to the extreme oversold condition the indices are now in the relief rally should be strong. The problem over the last few days however has been that too many people have been looking for just that relief rally. Too much bottom fishing has been taking place. It works like this: traders trying to buy the bottom tick before the bounce that everyone anticipates will buy as stocks trade near their daily lows. When stocks subsequently drift even lower stops get triggered and selling compounds. In other words, the bottom fishers are fueling the market's decline. So, theoretically we are very close to a bounce, but if too many people continue to bet on this then the market could be in real trouble here. Ironically, trying to buy the bottom tick before prices reverse, is becoming more and more risky the further the market declines. Why? Because some have been buying quite heavily into this decline and if the pain eventually becomes too great for them and they are forced to stop out the dam could burst and what started as a correction could turn into a crash. We are by no means predicting a crash. What we are trying to point out however is that trying to enter before the turn confirms itself is the best way to lose money in the market. Once the market capitulates there will be plenty of time to take advantage of the relief bounce. Stocks and markets just do not reverse in "V" type patterns leaving those who did not buy the bottom tick behind. Be patient here and be in cash until we have confirmation that the selling is drying up. As of Thursday's close, we have no evidence that buyers are regaining control.

The Bounce that Never Arrived, Will

Yesterday was a rare day when the crowds ended up being right about the market's direction. Support levels on the Dow and S&P cracked while the Nasdaq trailed off even lower. Put contracts purchased en masse over the last few days are deeply in the money. Keep in mind that Friday options expire and with stocks and indices more than oversold now it shouldn't be too difficult for options sellers to incite a short covering rally to at least recoup some of their losses. Put buyers would do well to take profits while they have them. Even so, this market remains a falling knife as of yesterdays' close. We can speculate that a turn is overdue but until that knife stops falling it is dangerous to get under it. A few potential bounce back plays are developing already and stocks that fell back on light volume should rally once the pressure eases. Other stocks that have fallen on heavy volume and that have broken their trends should be good shorts once they retrace some. In other words, opportunities abound in this market but we have to time them right. We are almost there.

Cash is a Position To

When we scan this market the only thing we see right now is a lot of ways to lose money. The refusal to capitulate has kept this market from a relief bounce and while we believe that we are very near a reversal this market still has a lot of falling knives. Until these knives stick in the ground they will continue to cut those who try and catch them. There are some tempting reversal set ups in the oils and industrial mining sectors but frankly we don't trust them. Selling pressure has been so strong over the last few days that support levels have not just been blown through, but gapped over. With a lot of trend lines broken and the Nasdaq crushing long term support we have to go with the idea here that the intermediate trend is down. Since surprises occur in the direction of the trend trying to buy a bottom in an expected relief rally too early can teach traders a very painful lesson. We have already learned this lesson so we remain sidelined here in this situation that just does not offer a very good reward for the risk that weighs. The fact that we are not getting any relief from selling pressure yet indicates that when the tide turns, we may get a very strong countertrend rally. This is why shorting is so dangerous right here; a lesson that the options crowd has not come to terms with. Options traders bought 5 put options for every call option yesterday betting on more downside from current levels. This tells us that a turn is very likely to come from these levels and perhaps could even occur today. Is it a good idea to buy now in anticipation of this turn? We would argue no. While indices may be ready to turn back up, at least for a relief move, a lot of stocks have sustained severe technical damage. Finding the stocks that will move back up significantly and the ones that will only tease you into a bull trap will amount to guesswork at this point. If we get a good strong capitulation day today or sometime this week, we will start to see some reliable set ups emerge. Until we get some capitulation or get a relief rally of some sort that sets up a better short play it is very important to calm down your urges to get back into the market here. This will be especially hard to do if you recently lost money. The worst thing you can do in this situation is redeploy your money too quickly in an effort to recoup losses. Keep the powder dry here because the patient will have some very strong trading opportunities soon. Try to get back in too early though and you will only find yourself further behind making it even harder to catch back up.

A Bounce Is Likely, but be Careful

Put purchases continue to be extreme indicating that a near term floor is likely in place. Yesterday the QQQQ found support at the neckline of a long term head and shoulders pattern and all major indices bounced as shorts booked their recent profits. Over the next couple of days we would expect to see the market move up in a countertrend rally as options sellers do their best to manipulate the market up to maximum pain levels hoping to make the contracts expire worthless. It is our opinion that this countertrend rally will not be tradable for anyone except those with the shortest of time frames. The path of least resistance for the near to intermediate terms is firmly down. It is our opinion that any countertrend rallies should merely be used to exit open long positions and to position into short trades. A lot of eager bulls will be ready to quickly step back into the market to regain recent losses. We believe that this will be a mistake. The strength of the recent sell off indicates that support levels we are now at will once again quickly come under attack. The best course of action at this time is to remain patient and to remain in cash while some of the oversold pressure is relieved. Recent selling is leading us to a very nice buying opportunity, but we are not there just yet.

Near Term Bounce is Due Early This Week

Options expire this week and traders are overweight on the short side so we would expect a pretty good floor to be in place this week. In fact, last week's heavy selling could snap back into a decent two or three day countertrend rally. We recommend using this rally to exit poorly performing stocks and for putting together your list of shorts. Last Friday's follow through selling appears to us to be overdone, but since we didn't get a late day bounce, set ups on either the long or short side are risky here. We recommend managing open positions today and taking a wait and see approach to the market as we begin the week.

We are Bullish Again; Sort of

As readers have noticed we have been bearish on the broader market for several weeks now. The Dow climbing while the Nasdaq lagged just didn't sit right with us. Likewise, it was very clear from our scans that stocks were not going up with the indices yet on the bad days stocks have been participating in droves. Yesterday's ugly day has been projected by the writing on the walls for some time for anyone willing to pay attention to the signs. When OEX traders bought five calls for every one put on Wednesday, we knew that the bottom was about ready to drop out. Options traders are by far the best contrarian indicator there is. When this group of not so lucky people get overly bullish like they did on Wednesday it is time to go short. So indeed the QQQQ broke its long term uptrend yesterday as we warned it might. Now the big question is what next? Well, the same group of options traders that were overwhelmingly bullish on Wednesday flipped to the overwhelmingly bearish side yesterday purchasing more than two puts for ever call. Their routine is almost comical in a twisted sort of way. Taking a bearish stance on the broader market over the next few months makes sense here but options are a time wasting asset. Their value depreciates over time and if you don't time the market just right your value goes up in smoke even as the market eventually goes your way. Taking a contrarian reading from this group of folks then we would expect to see the market, and specifically the QQQQs, find support very near yesterday's lows. In fact, this index ETF stopped right at its 200-day average. We may see it dip a bit lower today, but now is not the time to short tech. Bottom fishers very likely smell a bargain here and will buy beaten down stocks back up. When the market bounces it will be time to go short. We have drawn a likely scenario on this QQQQ chart:

QQQQ Support in Trouble

The QQQQ is in real danger of breaking down from its long term trend this week. If the angels don't step in and save it now (angels are an investor's term for institutions that step in and buy weakness) we could see a major support break occur. With the Dow and S&P still rising on weak volume should the Nasdaq 100 break down here, things could get very ugly in the US markets. We are very happy to be nearly fully invested in commodities and in the foreign markets at this point. We don't know what will happen with the US markets over the course of the next month, but risk is very high there and it is best to be placing your money with the alternatives we outlined in yesterday's report.

Strong Bullish Trends if You Know Where to Look

There are a couple of huge bull markets taking place right now and most people are missing out. Nearly every commentator we read is still hoping against hope for a rotation into the tech sector. The rising Dow and S&P continue to entice investors in with promises of a new leg up in the secular bull market. As they patiently await their shares to start climbing they will grow increasingly as selling pressures continue to erode good set ups. The frog is getting cooked ladies and gentlemen. Most have heard how a frog if placed in a pan of cool water will eventually remain in the water too long to its own demise if the water is heated gradually. This is what is happening in the broader market right now. A few blue chip companies are propping up the major indices and stocks beneath the surface are slowly and efficiently experiencing distribution. Yesterday the Dow and S&P rose on sick levels of volume. Volume is the fuel that drives the market and right now the market is almost out of gas. Driving home this point are the advance decline numbers. As the blue chip indices rose more than half of the underlying stocks were actually in decline. Even worse the put/call ratio on the OEX had speculators buying 5 calls for every put! Generally a put/call ratio of 2 calls purchased against every put reveals an overly bullish sentiment. 5/1 is more than extreme. Today the FOMC meets and speculators are making a huge bullish bet. But as we stated, there are a couple of huge bull markets taking place and most are ignoring them. Gold sliced through $700 oz yesterday and gold stocks firmed up on very nice volume. As incredible as it may seem this market still shows signs of accumulation and not a blow off top. Sure there will be corrections, but these will be buying opportunities. Oil likewise continues to put in a bottom and it too will likely make a new leg higher over coming weeks and/or months. The other bull market though is in ADRs (American Depository Receipts). Europe and Asia have a number of stocks that are in real bull trends – of the type we haven't seen in the US markets for over a year. Risk is comparably low in these trends and the reward is very promising. We are excited about these opportunities and are already profiting from them while the average investor continues to slowly cook in the pot of stew that smart money is serving up for them.

Market Hangs On Today's FOMC. Maybe. It Depends.

What can be said about yesterday's trading other than that the volume was poor? Considering the fact that traders are awaiting today's FOMC meeting with bated breath we can forgive a poor volume day like yesterday though. Today's meeting has the potential to be a market mover if they can shed more clarity on their position for future rate hikes. Last week the market was roiled after a bit of miscommunication via the media sent mixed messages about the Fed's future intentions. Clarity then will move the market, lack of clarity will likely lead to more indecision.

Indices Look Good, but We Remain Cautious

The weekly views of all major indices are solid as we enter the phase of the market not known for a great deal of strength. Indices are moving up despite pressures from oil and a falling dollar that has gold threatening the $700 level. We frankly don't trust the rally in stocks here but we can also find no reason to try and stand in its way. If prices want to go higher, who are we to argue with them?

Even so, while there are some bullish charts the majority of set ups are risky and require chasing prices higher. We prefer to stay with commodities and foreign companies in the form of ADRs at this time in order to avoid the risk we perceive priced in to the broader US markets. There are some very nice solid trends in Japanese and European ADRs at this time and the risk is much lower and more manageable.

We believe that those who stubbornly attempt to run with the broader market at this time will find as we have for much of this year that more than a normal number of set ups will fail. Time will tell and if by the end of May it is commodities that have corrected and the Fed that has finally relented and seasonality has proven itself wrong this year, then we will relent and admit that we were perhaps overly cautious. We are not holding our breath.

Meanwhile, we are happy to remain with the strong foreign and commodities trends that do actually have some promise here.

Bears Growled, but They Have no Teeth (yet)

Yesterday just felt nasty as the QQQQ pushed on support and stocks experienced demoralizing selling pressure. This caused a lot of people to buy put options in expectation of further declines. We said yesterday that a near term floor is in place and yesterday's action confirms this. Yesterday was very likely the dark that occurs before the dawn. The only major index that looks to be in real trouble here is the QQQQ. The SMH performed well and held its ground while the S&P and Dow held their highs. Will the QQQQ break down here? Not a chance. Put options purchased yesterday represent an overly bearish sentiment and the Qs are trading right at the support line on the trend that started three years ago. The market is weak here, but that support is not going to give way on the first attack. If today starts out weak, look for a strong intraday reversal to take place as support buyers step in and buy the weakness. If the Qs do break support today, the market is much weaker than we thought; but don't bet on it, at least not yet.

Temporary Floor In Place/Commodities Still Hot

The bulls were able to hang on after Monday's thrashing. A near term floor may in fact be in place here. Once again however the tech sector is lagging the blue chips. The Dow and S&P are trading at multi year highs and threatening a break higher while the Nasdaq and semi conductor indices are trading at support. Relying primarily on Japanese candlestick analysis, tech has support and should turn up from here. We have a feeling however that it will be pulled along by the strength of the Dow and S&P rather than move up on its own volition. Nevertheless, the long term prospects of the market don't appear to be in danger of breaking down just yet and we may in fact have a nice trading bottom in place. If the Nasdaq rallies weakly, it may set up a good short scenario, but let's not try and project too much here as the market is always full of surprises. A lot of people are looking for the metals sector to break down letting the money roll back into tech. We think that just the fact that so many are looking for this scenario to take place means that it will not. The market does a great job fooling the largest number of people; it always has and it always will. Some of the silver companies took a hit yesterday but this had more to do with nationalization threats from the country of Bolivia than it did on actual supply and demand for silver. In fact, the metal itself has a new ETF that lets those without commodities accounts to buy silver directly. Note that this ETF (ticker SLV) traded up yesterday as the mining companies lost footing. It may be that a lot of investors are rolling their money out of the companies, which in many cases are not fundamentally sound, and into the metal itself. Meanwhile gold, the metal, and gold mining companies kept right on climbing yesterday. The ETF (ticker GLD) is probably getting pretty close to a trading top, but a number of mining companies are still in the process of higher base building and we can find very few divergences that might indicate the miners are ready to break down. That other commodity that has everyone gnashing their teeth when they head to the pumps, oil, likewise continues to move higher. We believe that $70 will now act as the floor and that there is no end in sight for the climb in this sector. Pundits may be right, we may be on the verge of a rotation out of commodities and into tech but until we see it actually happen it all amounts to just so much wishful thinking.

Time to Get Rid of the Bad Blood

Yesterday the market left those who have been paying attention a not so subtle message. Recall last Thursday when the Fed Chairman's remarks sent market indices soaring off of support on high volume. You may also recall the fact that a majority of stocks did not participate in that ghost rally. Now, juxtapose Thursday's market reaction to yesterday's counter reaction, also spawned by remarks from a Fed Board member. When the market dropped back yesterday nearly everything participated. Many traders grumbled about the Fed making comments to the media, complaining that the Fed should be more careful with their words. We would point out however that the market was likely looking for an excuse to dump. As we all know stocks trading at multi year highs have recently been trading like they are stuck in the mud. We have argued that this is distribution slowly taking place. Yesterday confirmed for us that we were right; low breadth of participation on Thursday's rally, high breadth of participation on Monday's late day dump. Now we need to keep a close watch on the trend lines. As we pointed out a week ago, the weekly market trends were in tact and stocks were trading at support. Yesterday the QQQQ and Russell 2000 both closed right at their trends. The S&P and Dow are still trading a few points above their trends, but the Dow has very likely put in a top. Do we short? Not yet. As most everyone knows, picking a top in a bull market is risky business. You can be right in general, but not right specifically and if you don't have very deep pockets to ride out the bounces shorting tops can be very painful. The better risk-reward scenario is shorting the failed throwback rally, which often occurs after a trend break. Here's a good example: Note that after the blue up sloping trend broke, the price rallied back up to tag the underbelly of the uptrend. The price struggled at this level for two days and then gave way. As you can see, shorting the throwback is a much higher probability trade than shorting the breakdown. Should we be worried about a market decline here? Only if you are sitting on profits in your long term portfolio. In that instance you should be taking measures to protect those profits with trailing stops. As traders we should embrace these potential developments. With stocks losing momentum into their multi year highs, the number of trading opportunities that actually follow through and work for significant gains have been shrinking dramatically. A good washout is what the market needs to help reset new opportunities. Like Clemenza noted in the movie The Godfather: "This thing's gotta happen every five years or so, ten years, helps to get rid of the bad blood."

Energy and Metals Still Strong

If you merely focus on the index charts from a weekly perspective, we are right at support and ready to run higher. This is especially true on the S&P 500 and Dow. The tech sector however, while also at support, is showing signs of slowing momentum. We believe that this sector may once again lag the blue chips. Likewise, the small cap, Russell 2000 index is vulnerable for a correction. At this time it looks like institutional money is making way for a safe haven in the high liquidity blue chip stocks and it is avoiding high beta small caps and tech, but not necessarily selling these two sectors. Many commentators are looking for a rotation out of the energy and metal stocks as they believe commodities are overdone and likely topping. The truth is that the only true bull markets we are seeing right now are in energy and metals and trying to pick a top in a bull market is a recipe for pain. Market commentators will eventually be right in their calls for a rotation back into stocks from commodity-driven profits, but we believe that it is too early to make that call. We are seeing a great deal of strength in these two sectors at this time.

Indices Look Strong but Stocks are not Confirming

Yesterday we mentioned the fact that Wednesday's market felt a lot worse than it looked. This is because while the major indices were holding up, breadth was poor and stocks in general were just behaving badly. Yesterday morning we felt the brunt of this behavior as support levels were hammered and many many traders were whipsawed out of their trades. After the Fed Chair gave his speech, the indices rallied broadly and stocks that had shaken people out came back up, but most on low volume. Not the indices though. They rallied hard on very heavy volume as program trading kicked in at the prospect that interest rate hikes are history; at least for now. After a rally like we experienced in the indices we would expect to find a broad selection of strength and buy set ups. In fact the opposite is true. Today's scans showed that most stocks did not participate in yesterday's high volume index rally. Does this mean that smart money is gunning only a few index stocks to create a picture of strength when in reality there is none? It sure looks that way to us. We are now at the point of the month where we should see funds putting some money to work and that should keep a floor under the market and perhaps could improve the underlying technical situation. As of right now though, this market looks sick to us and caution flags are being raised. We wouldn't short this market yet, but definitely be careful here. Use your stops and don't buy aggressively. Don't get suckered into the idea that the market will rally now that interest rate hikes are done (or likely done). It may indeed rally, but let it show you proof. Don't buy in anticipation because right now the underlying story of the stocks just does not read very well.

Hung Over From a Demoralizing Day

Yesterday's market didn't look as bad as it felt. The Dow was retesting highs and the other indices were bouncing around their support levels. A lot of stocks we are watching however just drifted on a general lack of conviction. In fact, a lot of stocks were really struggling with support. Market leaders like BRCM just gave way to selling pressure and everyone's nerves are pretty much on edge here. We are now rolling into the end of the month with very little direction. Scans today didn't pick up anything that is really worth considering seriously as the lack of follow through in this market makes it clear that stock set ups are more of a gamble than a science. We expect to see buyers step in over the next few days, but we are agnostic about today. Unless everyone got a good rest last night and put their bull caps back on, buying window or not, today may just give us more of the same dreadful struggle that characterized Wednesday's trading. Let's hope our supports hold until buyers dare to show their faces again.

Semis See Signs of Life

The Dow may be ready to implode here but we are seeing a nice rotation into the tech sector taking place. Intel, which looked ready to take another leg down is being pulled up by a strengthening semiconductor sector. This is exactly the kind of strength the Nasdaq needs to see if it is going to make a strong rally.

Waiting Out the Weakness

As everyone who has been with us for a while knows, one of our rules is "Don't trade every day." Despite Jim Cramer's claim that there is always a bull market somewhere, some days just don't make for very good trading. Friday we experienced some weakness on what we believe can be attributed to expiration. Yesterday we did not get a strong recovery from that weakness and stocks again moved back into the choppy mode that has been so frustrating of late. Today we struggled with scans. Set ups that looked promising a day or two ago now look a bit limp. Generally when this happens we will see more weakness before strength returns. At a minimum we would expect to see today start out weak. A late day recovery would be promising, but we may see this slow drift downward continue into Wednesday. Trying to buy this weakness will only lead to more frustration as support levels will likely be pushed against or even temporarily broken. Late in the week however we should start to see buyers push the market higher as end of month buying kicks in. Traditionally this period starts around the second to last trading day of the month and lasts into the third trading day of the new month. Today is a good day to sit on recent gains and wait for set ups to firm up a bit.

Let's Cut Through the Noise to Find the Trend

Note: We apologize for the delay in providing this report. The blog site would not let us publish yesterday, likely because of server maintenance. Information here is still relevant. There are a lot of forces that move the market and depending on how you wish to interpret (or even mine) the data, you can build a bullish or bearish case that sounds very convincing and appears very sound. Our personal position is that with oil over $70, the commodities market in general on a tear, and the bond yield curve threatening to signal a recession, this rally doesn't seem to have much gas in it. We may ultimately be right and the correction we are looking for will very likely come at some point. But what do the charts say? At this time the index charts say that stocks are discounting all of our worries. Again, this may change, but you have to trade the tape that is right in front of you, not the tape that you anticipate. The tape right in front of us remains bullish. Let's take a closer look at the weekly index charts to get a clear picture of the real market direction. The weekly view is a very good tool for stripping away the noise and revealing the true direction. Starting with the Nasdaq 100 (represented here by the QQQQ): On Friday the QQQQ dumped most of last week's gains as oil rallied hard in the afternoon. Is the QQQQ going to now crash? Well, the weekly chart says that unless the price will close below $41.25 anyone who calls for a reversal in trend should be treated as Chicken Little. The sky is not falling here. With the weekly close at $42 we now have a weekly doji right at support. With the uptrend in tact, this is bullish.

Moving on to the S&P 500 (represented here by the SPY): Last week the SPY bounced off the trend, which started in 2003 and closed the week at its highest level since January of 2001. We can find no reliable signs of distribution here. In fact, our calculations reveal continuing accumulation. This is not bearish folks. We don't know how the market is going to respond to the worries we mention above over coming weeks, but technically the S&P is set to launch much higher.

Now let's look at the semiconductor sector (represented here by the SMH): The tech sector is going to be a lead weight around the neck of the market if the semiconductors can't find a bid. The SMH, as you can see below, is primed and ready to rally off of support. Unlike the S&P, there are signs of distribution in the sector, but this does not appear to be a threat to a projected rally. Unless the SMH closes below $36 any remarks that the bears have taken control of the market should be ignored.

Bottom line: Despite where you think the market is going or where you think that it should go, those who wish to make money need to react to what the market is doing right now. Right now the weekly charts are bullish so we stay long. This does not mean that we can let our guards down and stop using good money management. Indeed now is the time to exercise even more disciplined money management practices. Take profits off the table by selling at least partial share sizes into strength. Selling into strength frees you up to buy the dips and gives you the freedom to look at your positions much more objectively than those who hold and hope. This is an important lesson that takes pros years to learn. Save yourselves the time and heartache by learning today what takes others a lifetime.

It's a Rally Until it Isn't

We want to clarify our position on the market today. Recently we have made some bearish remarks regarding the longer term outlook of the market. We need to qualify these remarks. We have a thesis that the market is nearing levels where smart money will start to distribute shares to retail. If we are right this process could take several weeks before a real top is put in place. Right or wrong, our thesis about what is going to occur long term should have no bearing on how we play the current market. It is very important to play the market that is right in front of you. As hungry bears learned on Tuesday this week, it never pays to pick a top in a bull market. Bears lost money trying and ironically they actually helped feed the rally when they were forced to cover their shorts. A rally is a rally until it isn't. Yesterday some heavy distribution took place in the gold and silver markets yesterday. A top is probably not in place in gold, but it may be in silver. At a minimum we should see both groups pull back to their trend lines and a short may be had by those nimble enough to find a good entry in this wildly volatile group.

Still Rising, but Long Term Trouble May be Ahead

The rally continues and some very nice set ups are emerging. We believe that there is still money to be had short term. However, and it's a big however, we have to be prepared for reality to kick in next week when options expiration is out of the way, the bond market's continued weakness wears, and high energy prices refuse to pull back. We believe that this rally is the opportunity for long term players to sell and that we may be setting up for the first serious correction since early 2004. If the bulls can use strong tech earnings to push the QQQQ past $43, we may see a tradable rise into the $44 and even $45 area. Considering the great set ups we are now finding in our scans, such a scenario is a real possibility. Traders can make good money on the long side in this situation. As we mentioned yesterday, play what is in front of you, but don't get so caught up in the enthusiasm that you forget to take profits along the way. There are still some good opportunities to enter at support, but we would be very careful about chasing breakout stocks here. Next week we will get a better feel for how this immediate term rally is going to hold up. Right now we just want everyone to keep in mind that this rally, whether it takes us to fresh new highs or poops out here, is very likely the rally that smart money will use to do some real distribution.

Can Bull's Now Capitalize on Momentum?

Yesterday the stars aligned for the bulls. On Monday bears, for whatever masochistic reason, tried to sell the market early and bet on a breakdown. As we outlined in yesterday's report, a selling opportunity is coming, but it will be the rallies that create selling opportunities, not breakdowns. Betting on breakdowns near market tops is a fool's game. Monday's sell day merely took market indices back near support levels and the OEX crowd, one of the best contrarian groups, became overly bearish, buying two put options for every call option. Tuesday, bulls recognizing a free gift when it is handed to them, bought the market open and strength endured right up to the FOMC (Fed) meeting minutes release. Bears likely thought they had the opportunity to sell the news but bulls were handed another gift; the Fed made their strongest statement yet that interest rate hikes are nearly finished. The key phrase issued yesterday makes it clear that rate hikes are about to become history (at least for the time being: "Most members thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy." Today bulls face another challenge; can they manage a follow through? If recent patterns are repeated then the answer is only a qualified "maybe." Yesterday may or may not have finally convinced bears that an uptrend is still in tact. If they are convinced, they will cover their shorts and contribute to the rally by becoming buyers. Bulls also have to contend with continued oil prices, which could be heading toward the unthinkable $80-$90 range (remember when $70 was still unthinkable?). The main thing to do here is just play what is in front of us and be ready to react when the situation changes. Right now bulls have some momentum starting, we are getting some good set ups and stocks are still ignoring high oil prices. Over think this situation too much and you might miss out on some nice gains.

Shorts Once Again Jumping the Gun

Short positions by those who prematurely bet on a breakdown are likely to add fuel for a snap back rebound. We believe that this market is going to provide a shorting opportunity very soon, but it will be shortable once it reaches back near recent highs. Shorting breakdowns is usually a recipe for failure and we believe that will be the case here. The put:call ratio is back in overly bearish territory so support should be in place very close to current prices.

One Last Rally Likely in the Cards

Major indices have support at their current levels, but the uptrend started in October of 2005 is severely weakened. We expect support to hold at this point and we should see one last rally take place. It is likely that this rally will give long term holders a chance to exit their positions and should give traders a great shorting opportunity. We don't expect the market to reverse course harshly, but the uptrend has come a long ways without a correction. It is nearly due, perhaps as early as next month, for a 10%-15% correction. In fact, this toppy market has been tough on traders due to overhead distribution. Rallies have been getting stuck in the mud of selling above. Even so, we are more than likely heading into a trader's market where it will be long term holders that are most frustrated. Due to rising interest rates and global economic worries due to rising commodity prices and continued geopolitical problems in the Middle East, we could easily move into a trading range market that will make for some very nice trader's reversals, but that won't make a lot of long term progress.

Base Building Continues

Stocks continue to build a base at current levels and it is very likely that bears have put in a floor for us. Yes, this is a strange statement but the fact is that when either bulls or bears become overly exuberant or one emotion (fear or greed) begins to dominate the market prices are very likely to reverse from the near term direction it had been heading. In this case that means we should have a floor from which stocks will now begin to lift off from. Yesterday OEX traders bought twice as many puts as calls putting this sector in clearly overly bearish territory. Bonds pulled back, but we stated yesterday they might. This is now base building and not a slow bleed. Stocks may continue to chop around in front of the long weekend but we believe a tradable bottom is now in place. Note: The market will be closed tomorrow for the holiday weekend so we wish everyone a safe and happy holiday. Our schedule will be back to normal on Monday.

Carving Out a Bottom

The bond market, which has kept the stock market under pressure over recent days looks to finally be ready to provide stocks with much needed relief. Near term there may be some more backing and filling, but the bleeding has stopped and base building is underway in that market. Meanwhile, the Nasdaq has been the baby that has gotten thrown out with the bathwater over the last three days. Nasty pullbacks such as the one just experienced generally culminate with an unloading of the best positions right before the turn. Note the Nasdaq 100 ETF, the QQQQ:

For weeks this index struggled with the $42 resistance area. After breaking above on decent volume and basing the price sold back down to the $42 area, now support. Theoretically this area should lend support but we have to wait and see how the market handles this today to be sure. Volume was heavy on the pullback so there is no guarantee that support will hold, meaning we will be looking for a return to trend support at $41.50 before we get a buyable bounce. The Dow is in similar shape as money continues to flow out of the small cap Russell 2000 stocks into blue chips. Yesterday's bleeding stopped right at the Dow's 50-day average and right at it's uptrend line. The S&P on the other hand didn't fare so well yesterday. Recent breakout support failed to hold indicating that the breakout (which we have been calling into suspicion over the past few weeks due to its low volume) has failed. Unless a miracle occurs we would expect the SPY to pull back to the $127-$128 area before finding support. If the QQQQ can find support and the SPY can tread water we could see the divergence between these two indices start to even out a little, which would bring indices back to their norms.

Bottom line: If you are in the mood to short this market after three days of onslaught, you are too late. A lot of short positions were opened after Friday's sell off and negative breadth has hammered virtually everything out there. Action over the past few days has been very disheartening for longs but we are either at support or very close to finding solid support. Those short positions put on could potentially add fuel to the fire on a strong rebound if the bond market does indeed provide a relief rally over the next day or two. If you are long and crossing your fingers for support to hold the best thing that you can do here is continue to cross your fingers and hold and/or considering averaging in at these lower prices. Averaging down is not normally the best policy, but considering the fact that we are much closer to a bounce than to more real decline it makes some sense under the circumstances. We would avoid metals stocks at this juncture. They have gone a long way very quickly and could correct deeply. Corrections in this sector are still buying opportunities, but right now the sector is risky.

Upward Drift Should Resume Soon

Yesterday provided just what we would like to see after a panic sell off day like last Friday; a very light volume day that lacked follow through qualities. Bonds have yet to give any relief to stock prices but remain oversold and a relief rally should be in the works shortly. Stock prices want to drift higher from current levels and bears are surely frustrated that they couldn't get sellers to show up on Monday. Look for prices to slip a bit lower before finding support, but don't get overly aggressive on the short side. . We have a number of positions we are watching that have been pulling back to support. We don't want to be overly anticipatory here however so are waiting for the bleeding to stop before picking anything up. As stated, today may see a bit more weakness, but we expect that we are fairly close to a snap back reversal. Today is a good day to wait for better prices.

Bonds Sold Friday, but are now Really Oversold

On Friday we quoted Bob Carver regarding the bond market and its potential reaction to the employment report as follows: "If the bond market has taken his prediction to heart and the numbers turn out to be weaker than they expect, we could finally get that countertrend bond rally we've been looking for. And, that would certainly help the stock market rally as well. On the other hand, a very strong Employment Report could forestall such a rebound in bonds. At the present time, bonds are extremely oversold, so it will be quite instructive to watch the reaction of bonds to the report. " On Friday bond yields initially retreated as media called the employment numbers a "Cinderella Report" where numbers were not too hot, not too cold, but just the right mix to get the Fed to lay off future rate hikes. Bond traders took this initial enthusiasm as a chance to short though and rates soared causing a strong intraday reversal in the stock and bond markets alike. Note Bob's commentary: "…interest rates, which had appeared immune to Fed rate hikes up until the last few months, are soaring in a "bull market". When rates soar, bond prices drop and that causes the relative yield advantage of stocks over bonds to narrow. It also increases the cost of doing business and that reduces earnings. Thus, the result is that when interest rates trend higher, an extra "drag" on stock prices is introduced. When the drag becomes too large, selloffs result. Friday was one of those occasions. Bonds initially rallied on the Employment Report, but short sellers hammered that market, sending interest rates soaring and stocks came tumbling after, just as we warned you would happen. " Bonds, which were oversold on Friday before the further sell off are now very oversold however and we are even closer to that relief rally predicted, which should give stocks room to continue the uptrend shortly. Look for an initial follow through lower today, which could then easily reverse as more bears are trapped as they once again miscalculated the top in this market. Trying to pick and short a market top is a lot like the old story about the boy who cried wolf. Eventually the wolf is going to arrive and eat the sheep but there will be a lot of false warnings that occur before that happens.

Bonds to Make or Break the Market

The indices actually look quite healthy on their weekly charts. There will certainly be some backing and filling along the way, but the immediate trend is up and the dogs are running. We don't need to mention that breadth figures are still poor and that this run might be heading up on fumes because a rally is a rally is a rally and profit can be made only by trading with the crowd when the market is rallying. If the QQQQ can make it over $43 we see no reason why it couldn't run to $45 over the next four or five weeks; especially now that the semi conductors are coming along. "One of the issues that is now giving the market some relief, where it has been under pressure over recent months is the bond market. Today the market could get a real boost from the bond market depending on how bonds respond to the employment report to be released before the open today. Bob Carver explains this better than we can: A data challenge will come Friday morning in the form of the March Employment Report. While the headline numbers are purely fictional in terms of new jobs, unemployment rate, etc., the market will lap them up and trade on them (as they say in computer circles, "Garbage In, Garbage Out"). According to the current Treasury Secretary, John Snow, we should be looking forward to a strong Employment Report (his basis for such a prediction is uncertain -- most observers suggest his role is more of a cheerleader). If the bond market has taken his prediction to heart and the numbers turn out to be weaker than they expect, we could finally get that countertrend bond rally we've been looking for. And, that would certainly help the stock market rally as well." On the other hand, a very strong Employment Report could forestall such a rebound in bonds. At the present time, bonds are extremely oversold, so it will be quite instructive to watch the reaction of bonds to the report. If the report shows a strong economy and bonds don't sell off and turn around and rally, it indicates at least a short term trend change in the bond market to the upside. And, that would help light the fire under the stock market. Often it's better to simply wait until the news comes and gauge the reaction of the market to the news before taking a position. We've seen the bond market rally in the face of extremely bad news before (to the bond market, a strong economy is very bad news indeed).

Chips Finally Confirm the Rally

We were wondering if it was going to happen at all, but the weekly buy signal the semiconductors gave finally proved itself to be legitimate. As early as Wednesday morning the SOX index looked like a great short as it traded in a bear flag. Shorts were disappointed as the index, along with the SMH, exploded higher. This at least answers one question about this bull move. Sentiment is getting overly bullish, so look for a pullback at a minimum near current levels. This rally does look tradable and the longer term concerns we have been expressing shouldn't get in the way of making money in the short run.

Trade this Market, but don't Buy and Hold Here

The QQQQ has completely negated the head and shoulders top pattern with yesterday's follow through above $42. The only problem we have here is the lack of confirmation by the semi conductors, which still lag near their lows. Moreover, Intel looks like the second shoe is nearly ready to drop as it rolls over into the abyss off of its falling 20-day average. Since INTC is generally the leader for the chip sector, a gap down could have the potential to break support on the SMH (semiconductor holders ETF). We expect this market uptrend to continue, but there are serious signs of weakness here that make us think that large institutional money is using the rallies to sell. Institutional distribution can take place over weeks and even months but just be aware that sector divergences, such as the one mentioned here today, declining breadth on down days, and poor choppy trading in general show that we are getting closer and closer to a correction. On that note, we should once again mention that we would embrace a correction. It will clear out the extra risk in the market and reset the stage with better set ups all around. Likewise this market needs a good dose of increased volatility to reintroduce fear and greed. Complacency over the past months has made pulling money out of the market tougher and tougher. We can manage a correction as it is not likely to blindside us. It will blindside players who have gotten complacent, but that is the nature of the market.

Market Not Ready to Break Down

The first quarter of this year represented a strong showing by the S&P 500; one of the strongest quarters in some time. You could have fooled us. This market has not been an easy market to navigate. Every up day seems to have been followed with a distribution day, especially over the last few weeks. The trend is still up but we have to wonder if the trend is being used by smart money to unload their positions. Case in point: the SPY broke out above overhead resistance during the middle of March. At the time we remarked that the breakout was not to be trusted due to the lack of volume. Now over the last few days every attempt to rally out of this breakout has been shot down mid day leaving a series of selling tails on the daily candlesticks. Each mid day rejection and poor close represents a day when sellers used the rally attempt to unload their positions. This weekend we highlighted the fact that the chip sectors was trading at support and providing a weekly buy signal. We may yet see a rotation back into tech that is validated by a strong move in the chips. As of today however we just racked up more evidence that something is not quite right below the surface of this market. INTC sure isn’t helping the situation in the semis either. We don’t want anyone to panic at this stage as this situation we are describing is still playing itself out and the final outcome is not carved in stone. It remains a good idea to tread lightly in this market and stay hedged in the commodities sectors, which are acting much better at this stage than the general market is. Despite the weak close yesterday we believe that those who aggressively shorted yesterday’s decline might be in for the same type of frustration that longs experienced after buying yesterday’s open. From what we can decipher from scans, yesterday’s late reversal was just more market noise and not necessarily the final nail in the coffin that is going to lead to a waterfall type slide that bears are hoping for. More likely we will continue to experience more choppy trading this week that is going to frustrate all but the most patient of participants. Ultimately this action is going to lead to a larger correction. We just don’t believe we are there quite yet.

Despite a Feeling of Weakness, the Charts Say Buy!

From a daily perspective Friday’s weak close left much to be desired. The semiconductors especially look weak at this juncture. Panning out to a weekly view however the picture changes and a more bullish perspective starts to emerge. Note the fact that the SMH, though performing poorly on Friday, merely closed out the week with a doji at long term support. Indicators (not shown) reveal a strong buy signal on the MACD histogram and improving money flow into the sector. As weak as this market has “felt” lately there can be no clearer point where a market demands to be bought. Think about this in terms of an airplane pilot who is flying through heavy fog. His senses may tell him that he is listing or that he needs to adjust up or down but under the circumstances he must ignore his senses and fly according to what his instrument panel is telling him. In other words, his senses are unreliable and he must not follow his instincts but rather his training. Likewise, instinctually the market is telling us that we must sell but the charts are saying buy, buy, buy. A QQQQ failure at $42 and an SMH breach below $35.75 would negate the buy signals here, but we must buy here and react to a market breakdown if and when and only when such a breakdown occurs. "Ours is not to reason why, ours is but to do and die" -Alfred, Lord Tennyson's Charge of the Light Brigade.

Significant Strength in Gold and Oil

An inverted yeild curve on long term bond rates signals a recession down the road. As we mentioned the other day, it is likely that the Fed is engineering just such a recession in order to put a cap on rising commodities prices as well as let some air out of the US real estate bubble. A recession is likely a year or so off however and this week the yeild curve on bond rates moved up to test the downtrend line. A break above this line will give a boost to the stock market. A rejection will likewise cause the market to sell off somewhat significantly here. As we move into the end of the month of March the market is either betting on a yeild breakout or the monthly mark ups are masking the market's true intent. Likely we are seeing a bit of both play out here meaning that the going in the broader market could remain rocky over the next week or two. Meanwhile, significant opportunities are cropping up in the commodities markets as well as in some areas of tech.

Market Reacts to Fed

The Fed implied a continued hawkish position on inflation and in particular inflation in the energy sector. In order to do this they will have to seriously slow down the US and even world economies. The message the market reacted to yesterday was that the Fed is engineering a recession. This led to a second high volume distribution day in as many weeks. The long term trends established from last fall are still in tact and given that we are moving into the end of the month buying window we would expect that today will see a reversal from yesterday's downturn. This keeps us with our pattern of one day up, one day down trading that has frustrated so many over the past weeks. Major market trends have been sustaining some technical damage of late though and we believe it is just a matter of time before we see a more serious correction. Energy stocks are once again seeing signs of life and could be mounting another leg higher soon. It will be interesting to see how gold stocks respond to a stronger dollar; if the trend in the dollar continues the gold sector could be a short here. Many small cap stocks look like they could make another run. It is probable that some short term trades can be had on the long side with small caps, but profit protection is an absolute must in this market environment. The good news is we are starting to see an improvement in volatility levels, which should lead to more promising set ups on both the long and short sides of the fence.

Chips Continue to Experience Weakness

The semiconductor stocks, which had been showing nice support off their long term trend as late as last week, showed more weakness yesterday. The SMH reversed and rolled over after attempting to regain its 200-day average. If a rotation into tech is going to have any chance of working out, chips are going to have to start behaving a lot better here. At this time the market just feels very weak and breadth figures are very poor on market rallies and good on market sell offs. This indicates continued distribution and there is a good chance that support levels established by the multi month uptrends started last October are in jeopardy of failure. Don't expect the Fed to provide much help this week. They are very unlikely to provide the market relief by projecting when rate hikes will finally end. In fact, they are likely going to do what they always do; overshoot thier target. We are once again seeing metals and oil showing strength while not much is working in the broader market.

Week Ends Mixed

The week ended very, very mixed. If you have been following along you know that distribution continues to take place as the market attempts to climb higher, especially in the Nasdaq. At the same time the Dow continues to threaten a breakout to new highs and a rotation back into the semiconductors appears to be a real possibility. The fact that the Dow is showing strength is forbidding for longs since it implies that smart money is shoring up their defenses by moving into the safer, more heavily traded blue chips. The reasoning is that if the market does shake lower it is much easier to move a lot of money out of large float, heavily traded blue chip positions. Meanwhile support in the chip sector is puzzling when compared to poor action in broader tech. The Nasdaq 100 continues to trade in a nasty head and shoulders pattern and the Tuesday's attempt to nullify the pattern was met with a barrage of selling that led to an ugly intraday reversal. Even so, the following day bulls stepped back in and defended support at the bottom of the right shoulder. 1660 is the bottom of the range and a break below would surely take the wind out of the bull's sails. Likewise, a strong move over 1700 would indeed nullify the bearish pattern and keep the long term trend in tact. With the chips perking up here and given the fact that next week we should experience the traditional end of month buying there is a good chance that bulls will be able to nullify the pattern. Supports are thus far holding, but nevertheless, this is a market that just doesn't feel very strong. We have witnessed a great deal of subtle distribution as stocks continue to get chopped when they trade at the upper end of their ranges. The Dow continues to reveal a flight to safety (realize that institutional money makes up the vast amount of trading volume in the market and it can take weeks for them to set up their positions). Tops in markets are very difficult to predict and prices can continue much higher than it seems logical sometimes. Nevertheless this is a time to tread carefully and a time to either set up short hedges along side your long positions or a time to build up cash positions that allow you to take advantage of the market's next move whatever it may be. Low volatility choppiness that we have been experiencing for the better part of this year is going to lead to high volume and a large move of some sort. Either money that we can't see right now is going to come off the sidelines and bust through this heavy level of resistance the market is now faced with; or, the market will continue to drift precariously higher on light volume leading to a very dangerous situation; or the market will heavily roll over from current levels. Have no doubt though that something big is afoot. Note: Due to a heavy travel schedule this weekend we will not be putting out a report on Monday. We will be back to our normal schedule on Tuesday.

We May See a Bounce, But How Strong?w

Buyers have been stepping in at support and nibbling away at the dips. The market does appear to be gearing up for some more upside. What has been troubling lately though is the fact that every time a stock or an index appears to be making some headway profit takers come in and chop the legs out from under the move. Many commentators are blaming program trading for this type of behavior. If so, this would be indicative of smart money taking money off the table into the rallies, or subtle distribution. There are small pockets of opportunity out there, but this is really just not a good time to be getting agressive.

Bulls Battle Back, but Have Their Work Cut Out

Bulls took a counterpunch yesterday and defended the territory they had to defend. This is an interesting development but we stand by yesterday's analysis. Overhead resistance after the high volume reversal day is going to be formidible. Likewise, money continues to roll into the Dow and the S&P bounced on light volume. These are not good developments if you are firmly planted in the bull camp. On the other hand, tech showed some life yesterday and there is a very good chance we will see the semiconductors make a move. The SMH is bouncing firmly off the all important $35.50 level. The level to watch over the next few weeks is $37. If it can regain this level it may mean that the correction we are looking for may come more in the form of a rotation back into tech rather than a broad reversal of all major sectors.

Bears Snatch Defeat From Jaws of Victory

We have stated rather firmly over the past few days our distrust of the recent S&P breakout. Breadth was our first clue since a decreasing number of stocks participated in the breakout. In addition, the glaring fact that tech did not participate as the QQQQ lagged back at support, provided plenty of reason to be distrustful of any stock rallies from the current level. Finally, volume never confirmed. Now as you can see the breakout is in serious jeopardy of failure as the SPY rolled over on heavy volume yesterday. Now let's take a look at the Nasdaq 100. The QQQQ has been ranging between $40.50 and $42.00 for six weeks now. Yesterday a weak attempt to take out $42.00 was strongly rejected and the index reversed on heavy volume. Also note the uptrend line, now at $41.00 is in serious jeopardy of failure. It is pretty clear that we have an intermediate top in this market and it is fairly clear that we are gearing up for a correction. Keep in mind that there is no reason to panic here. The sky isn't falling and the end of civilization as we know it is not in the cards. A correction can play out in many forms and we have plenty of warning here to prepare our portfolios to handle one should it come. Our course of action is also pretty clear and at the time of this writing we can see one of two scenarios playing out: 1. Yesterday's distribution day will find some relief and prices will once again bounce weakly. If we get such a bounce it should be used as a shorting opportunity. 2. MSFT's after hours announcement will quell any relief rally and the indices will break down over the next day or two. Under this scenario it will be necessary to short weakness. Today we wait to see which scenario plays out.

Is the Cup Half Empty or Half Full?

Depending on how you want to look at it the market is either running on empty here or gearing up for a big rally. We've been exposed to both theories recently and they both have some merrit, depending on what you focus on. We are agnostic about the market at this time and we think a lot of people are in our boat. Certainly the recent breakouts on the S&P and Dow are not to be trusted, but does that mean we come crashing back to earth dramatically or do prices continue to drift higher because sellers are more frustrated than buyers? We don't know. What we do know is that this market is a mine field and navigation continues to be difficult just as it was most of the year last year and just as it has been most of this year. Along with a lot of other participants we would like to see a strong move get underway, whether it be up or down, just to get some exploitable emotion back in this market.

Bulls in Control, But...

If you have been following along you will notice that we have become increasingly concerned with market action lately. We had mentioned last week that we would like to add some short hedges. Our reasoning on this issue has to do with decreasing breadth as the market has moved higher. We frankly don't trust this move. Nevertheless, momentum has been picking up on the upside and while we believe that this latest bullish market move is on shaky ground and not to be trusted shorts are likely going to get burned unless they have deep pockets. There will be a time that this market needs to be shorted, but it is not quite here yet. In fact we could be moving toward a blow off type move, which will suck in a lot of retail money before a real correction ensues. There is no reason to be afraid of this market and money can be made on the long side. We just want everyone to keep in mind that the foundational structure that this move is building on is not sound and we want everyone to be prepared to switch sides of the tape to the short side when it does become necessary to do so.

Option's Expiration Skews Analysis

Any analysis we can offer in addition to what was provided yesterday will be tainted with the fact that options expire today. QQQQ contract writers are very likely going to get the price down to $41, the number representing maximum pain. Technically such a move is meaningless. It means that the price will remain in the trading range it has been in for the better part of the past six weeks. $40.50 still represents the bottom and $42 represents the top so unless one of these prices are breached we remain in a range and must think about the market in ranging terms, not trending terms.

Option's Expiration Skews Analysis

Any analysis we can offer in addition to what was provided yesterday will be tainted with the fact that options expire today. QQQQ contract writers are very likely going to get the price down to $41, the number representing maximum pain. Technically such a move is meaningless. It means that the price will remain in the trading range it has been in for the better part of the past six weeks. $40.50 still represents the bottom and $42 represents the top so unless one of these prices are breached we remain in a range and must think about the market in ranging terms, not trending terms.