Dip Buying Remains Strong

Bulls continue to relentlessly buy the dips as last week's dip back to support was followed by an explosive move back to the latest highs yesterday. What is most interesting here is the number of analysts who continue to doubt this market's move and the number of traders who continue to short the highs. In other words, this bull market has not yet reached the "point of recognition" where nervous retail longs finally realize that this is indeed a bull market and put money to work. They usually do so at the top, right before a correction. We have stopped trying to predict where this market may turn. Right now we strongly advice just taking what this market is giving – good long set ups – and leaving the top calling to those who are likely to continue fueling this move with their short covering. Protective stops should be used to take us out, not our human tendencies towards fearing the unknown. We read a great quote the other day: "if the market rewarded human nature, then nearly everyone would succeed." The wisdom behind that quote speaks volumes.

Trends are Bullish, but Extended

The QQQQ continues to look tired here. If it can make it back over $42.50 it is going to put a real hurt on a heavy institutional short position that is already hurting badly. However, if gets sold back down to $41.50 it will signal the beginning of a larger correction. The S&P and Dow both look much stronger, and while they are oversold and at risk for a pullback to their trend lines, dips remain buying opportunities. The end of the month should once again see a good rally take place. Since options expiration was last Friday, however, we could be in for some weakness as we start out the week this week. It is best not to get too aggressive until prices come back to better support levels.

Dip Buyers Continue to be Relentless

The sector to watch today is the semiconductors, which we like to track via the SMH. It has pulled back harshly to its 50-day average. If the current trend stays in tact, we should see it bounce today, which would prop up the QQQQ. Money flow into the blue chips continues to be good and even the tech sector has been finding late day support. Remember, the amateurs trade in the morning and the pros show their cards into the close. Pros have been buying the close for the past two days. So again, we remind everyone, don't be too quick to become bearish. The market may be overbought and may be near resistance, but signs of distribution are hard to come by.

Waiting on the CPI Reaction

Yesterday's PPI numbers gave the market a shake, but by the end of the day the Dow and S&P had almost fully recovered as dip buyers remained aggressive. A crack in the market's armor showed, however, as the QQQQ and semiconductor sectors reacted more harshly to the higher than expected inflation numbers. Likewise, the tech sector failed to make the same strong recovery that the blue chips were able to carve out. We are still projecting the rally in the blue chip sector will stay in tact for the next couple of weeks (and perhaps up through the November 7 elections). Tech, while not likely to turn into a downtrend just yet, will probably start to lag as it did last spring. Today's CPI numbers, if as inflationary or more so than yesterday's PPI, have the potential to knock the QQQQ back to support near $41.

Be Slow to Become Bearish

We could be facing a "turnaround Tuesday" today as indices looked a bit tired yesterday. We need to warn traders to be slow to turn bearish however. Dip buyers have been as aggressive as we have seen in some time and there are no signs yet that this is about to change. Breadth remains good and our scans continue to reveal a bullish underlying picture. The tech sector looked especially tired yesterday, but bears were aggressively buying puts at rates nearing 5-1 over calls. With so many betting on a top here it is unlikely that a top is in just yet.

Charts are Great, but Protect Your Gains

We would like to make two points today. First, don't forget where the indices are. Those betting on a large upside breakout at these levels are betting on the greater fool theory; that there will be an even greater fool to buy at higher prices. Keep cool here even if (especially if) the market goes into a panicked buying mode. Second, just because resistance is overhead and indices are not likely to make much progress, trade what is in front of you. If set ups are good, take them and protect yourself with a good stop loss strategy. Right now set ups are very good. Yes prices may turn at any time, but no one made any progress in the market worrying about what "could" happen. You have to take the opportunities that the market gives you and protect yourself against the turns by using good risk management.

Next Friday's Expiration May Cause Shorts Pain

The interesting thing about this rally is that it was never trusted. Even now with the market breaking out to new highs, there remains a high level of distrust. With options expiration a week from today, that distrust, which has caused aggressive shorts to sell into the strength, is likely to keep prices moving higher. Why? Options expiration generally works against those who have the potential to feel the greatest amount of pain. Right now it is the aggressive shorts that are getting squeezed, so the pain from expiration is likely to be pressed against them.

The Trend Remains Long Friendly

The bulls showed that they are still in control after a private plane crash in NYC caused a market scare. Volume on the recovery shows that bulls are still holding out for higher prices. As we stated yesterday, the trend is up until it is not. Right now it is up and it pays to stay long.

Keeping the Big Picture in Mind as the Market Climbs

We wish to keep today's report simple. We want to point out just a couple of points, that we think are important to keep in mind at this market juncture. First: the market remains in an uptrend until it's not. Until we have confirmation that the trend has broken, do not short dips or get scared and exit at dips. In other words, the long side is where the path of least resistance remains. The potential for a reversal is high, but the trend could possibly last until elections on November 7. Second: upside potential is small and downside potential is huge. Do not get carried away with the crowds buying breakouts at these levels. Breakout buyers at this stage are likely to end up as bag holders. On the chart below we have outlined where the QQQQ is at. As you can see, upside potential is muted, while downside risk is large.

No Update Today

There will be no report today due to traveling conflicts. Market conditions remain very much the same after Monday's session. There is no need to get agressive on the long side, but going short is probably premature at this stage.

Bulls in Control, but This is Their End Game

On Friday the market dipped, or rather the uptrend slowed, and options traders once again got bearish. No doubt about it, this bull run is in its end game here. Even so, as long as the crowds continue to get bearish on dips, the uptrend is likely to continue to chip away at their trading accounts by stopping out their short positions. The reason for this is relatively simple. The market rallies and the crowds get bullish. Short term profit takers sell the strength and the market dips. The crowd suffers a bi-polar-like mood swing and gets bearish, opening up large short positions as they attempt to pick the top. Subsequently, the trend (which is still up) reasserts itself and the new short positions add fuel to the rally as the crowds are forced to recover. This cycle will spin the market higher and higher and is the mechanics behind the phenomena oft referred to as "climbing the wall of worry." Eventually though, the crowd will learn the lesson and will begin BUYING the dips instead of selling them. When this happens, we can count on the fact that the top is either in place, or very close to being there. This week we wouldn't be surprised to see some consolidation or even pulling back. With the QQQQ and SPY both a few points away from overhead resistance, we would not count the uptrend over yet – especially with the crowds still selling the dips. Most likely longs will be tested this week and then the market will make another run higher before the uptrend finally starts to show signs of ending. Understand two things here and you will do well this month: First, this bull run is in its end game and downside risk far exceeds upside potential. Second, be slow to turn bearish, lest you find yourself being stopped out as prices refuse to follow through lower. In other words, wait for confirmation before going short, but don't be too aggressive on the long side.

Why Wednesday's Changed the Outlook

The Dow actually pushed above long term overhead resistance yesterday. Breakouts here are quite suspect, but momentum has the potential to push the market higher through the month, with a bit of backing and filling along the way. Risk increases now as momentum traders take over. For now we will try not to make any sweeping predictions and just ride the trend. As long as we continue to see decent set ups, it makes sense to stay long, using stop losses to protect against a price reversal. When this market comes down, it has the potential to come down fast. Until it does, however, this is no market to be short and long positions should continue to pay off. One brief comment about Wednesday's trading. Prior to the high volume, wide-range day on Wednesday, the market was at a pivotal point. Indices were at resistance. The market was likely to do one of two things that day; either break down or break out. Comments from the Fed helped it break out, which is why we were forced to shed our bearish posture. With the QQQQ breaking over its inflection point on Wednesday, odds seem pretty good that it will work its way back up to test last spring's highs. As it nears those highs, make sure to take profits into strength, but be slow to get bearish. This two month uptrend is at some point going to go through at a minimum a 50% correction. Until we get confirmation that the trend has rolled, however, over, it is a good idea not to sell the dips.

Bulls Deliver a Potential Knockout Blow

On Monday the QQQQ broke down from the rising wedge pattern we have been concerned with. Then on Tuesday the price rallied back to test broken support (then resistance). We were waiting for confirmation in the form of a follow through lower from that test in order to trigger a reason to get heavily short. Yesterday the market voted and confirmation was not to be. Essentially what we have after yesterday is a failed breakdown in tech and a rally which occurred with broad scale buying. Failed breakdowns must be respected for they generally lead to hard rallies. Over the past two months we have provided a lot of reasons why the market should not rally. The market has disagreed for whatever reason. Some suggest that there is a concerted campaign to pump and rally the market into November's election season. We don't know. This explanation is certainly as good as any other because the obvious reasons for the rally just don't add up. Whatever the case, a few important things have changed since yesterday. Market breadth was good, as was new highs among individual stocks. Scans, which have been dismal for the past few days, have now turned up quite a number of bullish set ups. Likewise, the Russell 2000, which had been lagging blue chips badly, has moved up to test resistance and is threatening a breakout. Should small and mid caps take over, the ensuing rally could be strong. At times like this, it is important to just take your lumps and admit defeat. In other words, if you can't beat 'em, join 'em.

Is a Rising Dow Bullish?

The media is cheering on the rising Dow as it pushed to yet another new all time high yesterday. Traders are hyping a rotation into the blue chips, arguing that we are entering a new era where blue chips will lead. We have to ask, these really bullish developments? By our readings, not really. The flight to blue chips is more indicative of institutional money that is getting nervous about the market. They have been moving out of the speculative small cap stocks (just check the Russell 2000 ETF IWM to see) and into the highly liquid blue chip sectors. This is what occurs at market tops not at market breakouts. And, since the Dow is leading let's take a close look at it. Below is the weekly Dow chart. Note that weekly resistance is at 11,840; just barely more than 100 points from yesterday's close. The Dow has been turned back at this rising resistance line each time for the past 2 1/2 years. Why should we expect this time to be different when tech lags and when speculative money is running for safe havens?

Note that the QQQQ accomplished the first leg (the up arrow) in the scenario provided yesterday. Now we wait to see if it will indeed be turned back at this area.

Bulls and Bears Likely to Be Frustrated this Week

Today we have two slightly competing theses confronting the market. First, the QQQQ broke cleanly from its rising wedge pattern.

Second, too many traders have been waiting for this break and put options sales were through the roof yesterday as a result of the break. When too many people in the market are looking for the same thing, the perverse nature of the market is to deny the crowds their satisfaction. We scanned everything today and there are just not good chart set ups out there despite the QQQQ breakdown yesterday. Longs are very likely to be frustrated as rally attempts should now get turned back at resistance. Likewise, eager shorts are likely to be frustrated today as follow through from yesterday's breakdown is unlikely. Very often when a major breakdown occurs, the underside of support is tested before the trend can establish itself. Evidence points to a test of resistance that gives false courage to bulls and frustrates overly anticipatory bears before the market can move lower.

We highly recommend not forcing a trade here. When stocks are not setting up the best policy is to wait until they are. Let the other guys struggle against the trendless environment and save your cash to take advantage of the situation once the smoke clears.

Friday Was Probably Meaningless

On Friday it looked as if institutions had achieved the prices they wished to close the quarter out at for the day was locked in a tight range. Breakouts where confined as sell programs kept a lid on things and then when prices started to roll over, buy programs put in just enough bids to keep prices from moving lower. As such, it's hard for us to make much of Friday's action and suspect that what happens today will be much more meaningful as far as helping us to determine what to expect next. The rising wedges on all three major indices should be the driving force that favors sellers this month. Today we would expect sellers to gain control of the market, but with last week's mixed messages, we are not making any strong predictions here. The most curious aspect of Friday's market was trading at the option's desks. Nearly 10 call options were purchased for every put option on the OEX desk. This is certainly drastically overly bullish, but when you get numbers like this, there could be alternative explanations that are much more benign. We'll just have to wait and see how today plays out.

Sentiment Readings Near Dangerous Levels

Today is the last trading day of the quarter and it serves the interests of fund managers for this day to close near current levels for the purpose of their reporting to investors. Of course it's irrational to use benchmarks, such as new all time highs for the Dow, to measure real investment performance. Nevertheless, headlines attract investment dollars into the market and keep the investors happy. Interestingly enough, scans show very little that would attract us into buying this market. Most of the movement in the indices over the past few weeks has been accomplished by large companies, such as Microsoft and Oracle, doing most of the heavy lifting. In fact, it is into the large float blue chip stocks that most money has been flowing. If institutions are worried about a breakdown in the trend, the safest place they can put their money to work – and remember, they must put their money to work by quarter end as the requirements of most funds are that the managers be fully invested as the quarter expires – is into stocks that offer enough volume to allow them a quick and relatively painless retreat once things start to slide. Yesterday the market held its highs in what we would consider a consolidation pattern. Major indices – in particular the Dow and S&P – seem to be gearing up for a spike higher. It is our opinion that the spike higher will attract sellers, but today at least there is a better than even chance the blue chips will close out the quarter on a high note. Several sentiment readings put traders at over 90% bullish levels, the highest they have been since right before the 2001 market collapse. While the market may look good after today's session, unless you are daytrading this is certainly not the time to be going long the market.

Selling Tech

The Dow made a new high yesterday, causing the media to turn on their hype machine, which finally convinced the crowds to buy this rally as measured by the OEX options pit, which sold nearly 3 call options on the S&P 500 to every put. This is where smart money wants the crowds. Smart money has been unloading into this rally as we showed yesterday. With the crowds finally reaching levels of exuberance, now smart money is able to short heavily into the euphoria without creating too much of a panic. The blue chips may have another day or two or even three to rally or at least maintain their highs. The QQQQ on the other hand, has lagged and is now primed for a top. Note the rising wedge pattern that has confined this rally over recent weeks. Yesterday the price bounced off overhead resistance, but found weak late day buying. Today, now that the crowds have had a chance to go home and watch the news and read their journals, they may be in an early buying mood today. This could theoretically push the QQQQ up to or even above $41. There we would look for sellers to step in heavily. For the second week in a row the SMH has been rejected at $35. Yesterday's hard reversal and failure to bounce at the end of the day even as the broader market recovered somewhat, is the canary in the mine that has stopped singing. This sector is the leading indicator for the broader tech sector and this sector tells us that tech is weak. Tops take time to form, but while the blue chips are working out their top, we suspect that, like the last top in April the QQQQ will start to come down early.

Time for Caution

In August, right before the market began to rally, we ignored an important buy signal in lieu of chart and volume patterns, which indicated more downside. Because we ignored this signal, we were caught on the wrong side of the trade. Now, interestingly enough, we are getting the same signal, only this time in reverse. NASDAQ 100 emini Sell Signal: At the beginning of August, futures markets for the NASDAQ 100 emini contract showed a breakout in money flow, which preceded the breakout stocks. Now the same contract has a money flow indicator that reveals smart money selling into the current rally.

Also note the important break in the uptrend line yesterday, even as QQQQ shares traded higher. Adding insult to injury, the S&P 500 made a new 5-year high yesterday, while the NASDAQ lagged significantly. This type of bearish divergence has preceded each failed rally for several years now. Gaming Window Dressers: End of month window dressing has been increasingly gamed by traders who have learned the pattern. Not that long ago window dressing would result in rallies which took place during the last three days of the month, and sometimes extended into the first two trading days of the following month. Now, however, traders have been taking advantage of the rallies and selling into them during the later days, causing the rallies to start to fizzle during the last day or two of the month. If this pattern persists, it means that today should market the last day where window dressing is able to push the market higher. S&P Rising Wedge: One of the most bearish of all rally patterns is the rising wedge, a pattern we have highlighted several times over the past few weeks in the S&P 500 index. We have hypothesized that before this wedge gives way to selling, a strong upside breakout would occur in order to draw in bag holders. Yesterday we got the initial move of just such a breakout, as can be seen below.

Window dressing may take this breakout up another day, perhaps two, but we argue that this breakout is very likely a bull trap, which will fail only to send the index tumbling back down to July lows during the month of October. Of course this last point is only speculation, but the rising wedge pattern is fairly predictable and given the divergence with the NASDAQ, the emini sell signal, and the fact that the 4-year Cycle low has not yet exerted its pressure, we think there are some pretty good reasons to take a seriously defensive posture starting this week. Once current buyers walk away and sellers are left without competition, this market can come down fast.

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Time for Caution

In August, right before the market began to rally, we ignored an important buy signal in lieu of chart and volume patterns, which indicated more downside. Because we ignored this signal, we were caught on the wrong side of the trade. Now, interestingly enough, we are getting the same signal, only this time in reverse. NASDAQ 100 emini Sell Signal: At the beginning of August, futures markets for the NASDAQ 100 emini contract showed a breakout in money flow, which preceded the breakout stocks. Now the same contract has a money flow indicator that reveals smart money selling into the current rally.

Also note the important break in the uptrend line yesterday, even as QQQQ shares traded higher. Adding insult to injury, the S&P 500 made a new 5-year high yesterday, while the NASDAQ lagged significantly. This type of bearish divergence has preceded each failed rally for several years now. Gaming Window Dressers: End of month window dressing has been increasingly gamed by traders who have learned the pattern. Not that long ago window dressing would result in rallies which took place during the last three days of the month, and sometimes extended into the first two trading days of the following month. Now, however, traders have been taking advantage of the rallies and selling into them during the later days, causing the rallies to start to fizzle during the last day or two of the month. If this pattern persists, it means that today should market the last day where window dressing is able to push the market higher. S&P Rising Wedge: One of the most bearish of all rally patterns is the rising wedge, a pattern we have highlighted several times over the past few weeks in the S&P 500 index. We have hypothesized that before this wedge gives way to selling, a strong upside breakout would occur in order to draw in bag holders. Yesterday we got the initial move of just such a breakout, as can be seen below.

Window dressing may take this breakout up another day, perhaps two, but we argue that this breakout is very likely a bull trap, which will fail only to send the index tumbling back down to July lows during the month of October. Of course this last point is only speculation, but the rising wedge pattern is fairly predictable and given the divergence with the NASDAQ, the emini sell signal, and the fact that the 4-year Cycle low has not yet exerted its pressure, we think there are some pretty good reasons to take a seriously defensive posture starting this week. Once current buyers walk away and sellers are left without competition, this market can come down fast.

As Long as Everyone is Bearish, This Rise Will Continue

A few days ago we used the analogy of The Little Boy Who Cried Wolf in relation to the market's uptrend. We pointed out that as long as the market participants continue to try and time the top by buying puts into the rallies, the market would keep on climbing the wall of worry. Each time the market rallies higher, these shorts are required to cover their short positions at their stop loss points. Covering shorts drive the market ever higher. Eventually they will learn the market's lesson and stop shorting the rallies. When this finally occurs, the market, which has been crying wolf, will then reverse. The time is not yet considering that 2-1 puts were purchased against calls yesterday. This market could be headed for a blow off top this week, which will hopefully finally convince the bears to turn bullish. When they do, we can get the correction that we admit we have been way to anticipatory of. Much of the current strength can be explained by end of the month window dressing. Later in the week it is likely that this will be faded and we could see a quick reversal that at least does the job of shaking out the bulls. We are likely to see higher prices before that occurs though.

Window Dressing Should Prop Up Weak Market

With indices overbought and near extreme resistance levels it is getting too late to buy, bar for a few specific issues. Likewise, now that we are entering the last week of the month, fund window dressing (an illegal, but oft performed activity) should make life difficult for the shorts. As we move into October, the chances for a larger correction increase. The semiconductors have already likely seen their top as can be seen in the weekly view of the SMH below. Note the inability of this ETF to make it over resistance at $34 over the past four weeks. Each attempt has been met with stiff selling. Why is this index important? If you recall, it led the way up in this oversold rally that is now showing signs of aging. There remains potential for the S&P to test its highs this week. We will be surprised, but not completely shocked, if the QQQQ is able to also test its highs. We would use late week strength to look for short positions. Finally, for those feeling a twitch of concern at our market outlook, consider that after a corrective retracement, the probabilities for a strong late year rally are very good.

Market Cracks Some More

Profit taking yesterday and a continued divergence between big caps and the small caps and semiconductors shows that the cracks in this trend are increasing. We won't call it a top unless we see the S&P 500 break below 1310 though. Don't forget, we are nearing the end of the month where buying usually picks up.

SMH Fails to Make a New High

The tech sector had in fact not made a top as yesterday provided. The market did prove to utilize the bear trap as we predicted it would. Longs have been extremely aggressive in this market. This does not mean that we are closer to a true break out than we are of a more serious correction. The first crack in the trend is the fact that the QQQQ made a new high, but the semiconductors (original leaders of this rally) did not confirm. The QQQQ is making new highs on the sudden enthusiasm in the old guard stocks ORCL, MSFT, and CSCO; all of which are extremely extended and nearing resistance

Monday's Scenario Still In Play

Yahoo sneezed yesterday, traders dumped their positions in panic, and the options market was stormed with orders for put contracts. What does it all mean? That the bear trap has been set and that the top is probably not yet in place. In order for this bear market rally to top the market first has to teach the crowd to lean the wrong way so that it can catch them in a "hold and hope" situation as their positions slowly erode. In order for the market to teach the crowd this perverse lesson, it has to cry wolf a few times (referring to the story of The Little Boy Who Cried Wolf). Yesterday, we believe, the market cried wolf yet again. If the market rallies higher from here, stopping bears out of their positions once again, they will likely have learned the lesson that the market is trying to teach: that is, if you short me again, I will burn you again. But alas, once that lesson is learned and the crowd learns to be afraid of the short trade, then the market will get what it wants: a downtrend with as few people on board as possible. In fact, this plays out well with the scenario we drew on Monday. The S&P has now pulled back near support. A reversal here and a new high would catch the most people unaware and the market always takes the path that catches the most people off guard. A push higher from here would very likely get a lot of people bullish and would allow smart money to make their final distributions. The crowd will then very likely hold those positions they bought here at the top all the way down to this summer's lows. If the market then takes out those lows, those who held and hoped from the top will very likely release their shares at much lower prices to the same smart money crowd who sold to them at the top. This is why we say that the market has a perverse nature. Bottom line: We will be eyeing carefully any strength as we enter the end of the month for shorting opportunities. And, should the four year cycle low take the market back down to this summer's lows, we will start looking carefully at weakness for good long opportunities. The tech sector remains weak here and may have already put in its top.

Buyers Still in Control/Tech May Have a Top

The QQQQ left a doji and the semiconductor sector tailed off at the top yesterday as profit takers nervous about giving up gains kept the tech sector from extending its gains. It looks unlikely that the tech sector indices will be able to mount any further gains from here without first correcting. The S&P and Dow are in sideways corrections, so the scenario we drew yesterday, which indicated a dip, then a rally, then a sell off, may actually skip the "dip" stage as oversold pressure is worked off in a sideways pattern. Nevertheless, there should be some good long and short side trades that last through the end of the month.

Support Test Coming Up

Friday's high volume gap up on the NASDAQ marked what is likely a near term top. Over the next few days we are likely to see indices work their way lower back to support levels. Currently the QQQQ has support at $39 and the SPY at $131. We will be operating under the thesis that the market will bounce from support as the crowd once again becomes too quickly bearish. The following bounce then should take early bears out of their positions as the S&P tests overhead resistance. From there, however, we should see the larger 4-year cycle reassert itself (see SPY chart below). On September 5 we outlined five reasons why we were expecting the market to return to this last summer's lows before it provides a true longer term buying opportunity. We were a bit early in our analysis at the time, but those reasons remain valid and by October they should assert themselves on the market. The QQQQ set up is a little more unclear as it has shown good relative strength lately. The bottom line: We are seeing some good long set ups at this time that should continue higher over the next couple of weeks. As we enter October the market becomes more vulnerable to a larger correction. Should the above scenario play out like it looks like it might, the return to the summer lows will provide an excellent long term buying opportunity. Participants are likely to be extremely bearish at that point and those who play it cautious as the market makes its top here will be in great shape to capitalize at very good prices indeed.

Watching and Waiting

Today is triple witching options expiration, which is accompanied by several economic reports that are being looked to with anticipation. We will withhold comments today and wait to see how the market responds. Remember, it is not important what the news is, but how the market responds to that news that is key. Take a breather today and don't open new positions.

Pavlov's Lesson

Over the past 18 or so months the market has become increasingly less volatile as upside breakouts have been stymied by sell programs and downside breakdowns failed to gain momentum. This period of time has trained trades, including admittedly us, to distrust large market moves and to bet firmly against them. This "lesson" the market has been teaching is very much like the stimuli that Pavlov used to train his dogs. This pavlovian response caused a lot of people to distrust this rally and as such the rally scaled a wall of worry unlike one we have seen in quite some time. Up until yesterday, puts were purchased on every dip causing subsequent covering to drive the prices higher and higher. Even so, we need to be careful here as the market is very close to reaching that point of recognition which will cause the tables to turn. As mentioned yesterday, the rally on Tuesday quite likely pushed back the expected correction another couple of weeks. This is not the time to lose our heads. That said, the market internals have been quite good over the past couple of days as breadth has improved immensely and stocks making new highs continues to grow. There should be some long side plays as long as good trailing stops are used to protect against any downside. For the time being, we are going to abstain from any further predictions and stick with what is right in front of us. We are also going to try and take a bit more risk since being too conservative has kept us from participating in this rally. What is in front of us today are a few decent long side set ups. Will they follow through? It's likely, but who knows for how long?

Bulls Refuse to Give Up

After a weak rally built on poor volume and breadth, volume followed through yesterday and breadth turned utterly bullish as fund managers worried that they had missed the bottom for the year piled in. The head and shoulders pattern that the QQQQ had been putting together was denied after the index sliced through its 200-day average and closed at a new near term high. We continue to believe that the market is very vulnerable for a correction. However, yesterday's rally (based on dropping oil prices and speculation that the economy is due for a soft, rather than hard landing next year) very likely pushes back the expected correction toward the end of the month or even as late as early October. We are looking for the QQQQ to drift lower toward Friday's options expiration as options sellers "park the car" into maximum pain prices. Maximum pain for the QQQQ is $39 this month. The bottom line here is that you can't argue with the market. Has this rally been built on a poor foundation? Yes. Is it possible that yesterday's strong rally occurred based on spurious reasons? Yes. Can the market continue to rally higher than seems reasonable? Yes. Will it eventually correct and come back to build a better base? Yes.

Watching Tech's Head and Shoulders

We are doing our best to stay objective here and look for the bullish case to balance out our current bearish outlook. It's not easy to do however when even after two up days in a row now scans do not produce any long side set ups that don't scream "Risk!" The big story yesterday was the huge follow through lower in the commodities sectors. Oil stocks crashed through support levels on their double top patterns and the metals crushed their last line of support on heavy, heavy volume. This led to what could possibly be a rotation into the tech sector, but if so, it begs a question. If money that is rolling out of commodities is moving into tech, why did tech only experience a weak rally yesterday that was turned back at right shoulder resistance of the head and shoulders patterns we pointed out in yesterday's report? There is a huge amount of money leaving commodities and yet breadth was only slightly positive in the tech sector yesterday and it was negative in the blue chips (more stocks were down in the S&P than were up). All these negatives we keep harping about lately do not mean that the market cannot go up from here. They do probably mean that any upside move is likely to get knocked back down hard though. As mentioned, yesterday's upside move fits in well with the thesis that tech is trading in a head and shoulders formation. Any follow through higher today that sticks into the close would negate this hypothesis. What is very clear is the fact that things are just not real clear in the broader market and with options expiring Friday, it's difficult to trust this market. With so many unknowns, it's better to stay with open shorts and wait in cash with the rest of your money. Note: we would like to get short more commodities. If the sector can experience an oversold bounce here it will be worth looking for entry points. If it just keeps heading lower, we will likely have missed a speeding train lower.

Three Potential QQQQ Scenarios

Options expire this week, but bulls and bears are fairly even, so hopefully undue volatility will be held to a minimum. On Friday the market bounced, but it looked to be more of a corrective move off of the overly bearish sentiment that was building since the market reversed last Wednesday. At this point, the QQQQ could be building one of two patterns: Head and Shoulders top (bearish)

If this is indeed the case, we should see the price bounce around between $38.00-$38.70 through options expiration, and then potentially break lower. Cup and Handle (bullish)

If, however, the QQQQ is forming a bullish cup and handle pattern, we might see the price move back to fill the gap at $37.70, only to reverse and then potentially break higher. The third scenario could be that the market is done pulling back and prices will follow through higher from Friday's rally. Technically this should not happen, but as we found out a few weeks ago, you can't apply logic to the market's actions; it sometimes just goes where it reasonably should not.

No Advantages to Forcing a Trade

With the S&P now breaking the lower support line on the bearish rising wedge pattern, the path of least resistance is now down. As we mentioned yesterday, however, there are too many bears out there to get much downside momentum started. We saw this play out yesterday as dip buyers stepped in, probably in response to ultra bearish sentiment, and kept a bottom under the market. The QQQQ tried to rally yesterday, but sold off in the late day, indicating that sellers are in charge, even though sentiment is giving some support. Drilling down to our scans, though, we find a very neutral near term picture. Reading the indices, we need to keep a bearish bias until we have a better reason not to. At the same time, we struggled to find anything that constituted anything close to a reliable trade set up on either the long or short side. When stocks are not setting up, it is always best to go to the sidelines and wait for better developments. There is no better way to lose money in the market than by forcing a trade. Days like today are best traded only by day traders. Days like today are usually short-lived and those who are patient and keep some cash on the sidelines waiting to act are quickly rewarded as better set ups emerge in their wake.

Stay Patient, Sentiment Will Swing Again

Yesterday the QQQQ (NASDAQ 100) left a strong sell signal as it failed at major resistance. On the chart below, the green line represents the 200-day average. On Tuesday the price closed strongly above this line, which we described yesterday as a temporary head-fake move designed to entice enthusiastic longs to buy more shares. Yesterday's gap back down and subsequent strong volume sell off confirmed our theory. The tech sector will probably bounce from yesterday's lows, but now any rally attempts are very likely to get stuck in the mud and prices will begin working their way lower; frustrating any hopeful longs who buy the dips. The SPY (S&P 500) moved down to support yesterday, but it has not yet provided a sell signal. Money flow perked up at the end of the day indicating that smart money has not yet determined that the rally is completely played out. There are just too many retail traders who have quickly jumped to the bear camp after yesterday's weakness. The market's perverse nature is likely to frustrate put option buyers by failing to provide immediate gratification. If the SPY can break below the blue uptrend line it closed at yesterday, it will signal a sell.

Right now we wouldn't be surprised to see the blue chips retest the highs. Should the S&P turn quickly around here and move back up to 1325, which we outlined yesterday as a magnet price for this index, those who turned bearish so quickly yesterday will very likely get bullish very quickly. The bottom line is that tops take a while to carve out. We expect to see some good shorting opportunities in tech over the next trading day or two. What we are going to be looking for is a bearish divergence between tech stocks and blue chips. If the S&P can indeed retest its highs, but the NASDAQ and semiconductors can only manage a weak bounce, we will aggressively short tech. If on the other hand the S&P is so weak that it can't hold support, there will be a number of breakdown plays, which should also provide shorting opportunities. Go long today if you are day trading, but don't look for any sustainable rallies to develop from here.

Be Careful Here

The S&P is just about back at formidable resistance (1325). This area will likely act like a magnet as bulls seek to drive prices higher, keeping bears off balanced. The QQQQ temporarily regained its 200-day average, but with the semiconductors still struggling, it is unlikely that this index will be able to surmount much more of a gain from here. This is especially true with the bond markets struggling. Right now it is best to sit on your hands if you have the urge to go long. The prospects for any meaningful price gains from here are poor. Shorts should start nibbling on positions as the S&P closes in on 1320-1325.

What September May Hold

Today large money managers return from vacation in droves after spending the hot months of August in their vacation homes. Below we are listing our reasons for why we believe the institutions will unload their positions in September and why we believe that an excellent buying opportunity is coming later in the month. So, if you missed the latest rally out of distrust like we did, never fear, there will be a second and better chance to participate at perhaps even cheaper prices. Reasons we are looking for a decline from here: 1. During the last two weeks of August the market rallied, but on decreasing volume. The QQQQ rallied right into its broken 200-day average. Take a look at the volume patterns during the decline from April and the late summer rally. Note the increase in sellers on the way down and the decrease in buyers on the way back up.

2. Likewise, the S&P 500 and Dow have rallied back to their April failure points. However, note the notable decrease in stocks making new highs during the latest rally (the yellow bars represent stocks making new highs, while the blue line represents the S&P price levels). This is a very strong bearish divergence, which makes a breakout to new highs very unlikely.

3. September has traditionally been the worst month of the year. This September the market is facing an additional seasonal factor, the reliable 4-year cycle. Longs have thus far done a great job at shaking out early shorts from their positions, which is generally what happens right before a large market move. 4. Overly bearishness has given way to overly bullishness. Last week Baron's magazine was cheering on the market as it approaches new highs. Money managers have a perfect opportunity to book profits into the crowd's enthusiasm. 5. Market volatility levels are back near all-time lows; another measure of the crowd's complacency as the market moves back up to test its highs. Bull markets climb walls of worry, and there is just not enough worry to move the market through the ceiling. Summary: Given the fact that the market has rallied for two weeks on low volume, that fewer and fewer stocks are making new highs even as the indices are nearing their highs, and now that the crowd is getting excited, it's a good time for the 4-year cycle to reassert itself. Outlook: Not all is bleak. Tech has shown some excellent relative strength and there are murmurings now that the Fed will once again start lowering rates to stave off an impending recession next year. The bond market has been behaving in such a way as to indicate this is true. September could be an ugly month for the bulls, but if the market is able to move back down to its June and July lows, we will be buying madly as this will mark a clear opportunity to take advantage of what is shaping up to be a strong rally in coming months. If you are worried about the market, make sure you are not mixing up your time frames. The outlook is pretty bearish directly ahead, but not so many weeks out in front, the outlook becomes much more bullish. Today: As we mentioned, the financial magazines and the crowds are fairly bullish after last week's strong close. The S&P looks like it wants to make a run back at its May highs. Meanwhile, money managers are going to come back looking to book profits made by their assistance and programs over the past few weeks. Early week enthusiasm then makes for a very nice opportunity to sell into strength. For the reasons we outlined in today's report, any further strength is not to be trusted.

Watch the SMH for Signs of Profit Taking

The SMH is now firmly parked at resistance so we would expect to see profit taking start at any point. Other resistance areas pointed out in yesterday's report are also looming. Next week we will get a better picture of the market's near term intentions. Note: We plan to take off tomorrow for the holiday weekend. We wish everyone a nice and safe holiday.

Watch Out for Rising Wedges

The rising wedge pattern is one of the more reliable chart set ups as the contraction of price movement as prices rise reveal the fact that bulls are running out of fire power. Note the S&P 500 traded in a rising wedge pattern from the first of the year until April, when a breakout attempt proved to be a head fake and the price subsequently plunged into a two-week free fall, which gave back the entire gain from the previous five months.

Now take a look at the current S&P chart, represented below by the SPY (ETF) exchange traded fund.

The wedge here is in a much sharper uptrend, but the price is contracting nonetheless. Could the bulls rally the price of the SPY back up to $132? We don't know yet. But if they did, there would surely be a great deal of capitulation amongst the shorts. Likewise, given the low volume in which this steep climb has been driven with, the probable reversal could be sharp and swift. Now turn your attention to the QQQQ, which has been behaving a little better lately. Below we are providing a weekly view of this ETF. Note the red line on the chart just above $39. This represents the 50-week average. Note also the blue trend line drawn on the chart. This line represents the last broken uptrend. Stocks and indices often move back up to retest their broken trends before reversing. We don't know what exactly to expect next, but it is clear that any further rally from yesterday's close is sure to run head long into some serious resistance.

Finally, let's take a look at the semiconductor sector, represented below by the SMH ETF. The semiconductors actually look pretty good lately. They appear to be in a decent uptrend that is rising on decent volume. Also note, however, that yesterday's sharp move put the sector right near overhead resistance, as represented by the rising trend channel. Furthermore, $34.28 represents the broken 200-day average. Thus, any further rallies in this sector are also likely to run into heated resistance. The semi conductors could actually produce some good long side trades after a pull back if it is orderly. For now it is too late to try and catch this trend.

Bottom line: Professional traders are expected to return next Tuesday after the holiday weekend. Any breakout attempts following yesterday's strong close should be eyed very suspiciously. No one knows for sure what will develop next week, but several indices are poised for serious downside if the pros come back with selling on their minds. If, on the other hand, they come back in a buying mood, further upside is likely to be muted by serious overhead resistance. In other words, be extra cautious if you are trading the long side of this market and don't get too aggressively short unless we see some breakout failures start to emerge.

Bulls Need to Step Up as Time is Running Out

Tech indices appear to want to continue drifting higher as we move closer to the end of the month buying window. The blue chips, however, found serious resistance overhead as they tried to break out yesterday and once again the S&P and Dow sold off into the close; a bearish sign. The problems with this rally are pretty much the same problem all recent rallies have had lately. Volume is poor, breadth is poor, and there has been a disconnect between the indices. Blue chips have moved way out in front and tech, while making a decent catch-up move, continues to lag. Overall the technical picture isn't terrible, and is for the most part neutral except for a couple of reasons. First, while we are seeing some areas of tech make strong moves, reliable breakouts are not setting up in the sector. We are also seeing more reliable short set ups than reliable long set ups. Most significant, however, is the potential for the bond market to sell off later this week. Technically bonds are ripe for a sell off, which would likely put a nail in the coffin on the bullish case for stocks. Stocks can still improve and rally, but time is on the side of the bears here. The longer the bulls wait to put their technical pieces together the weaker their case becomes.

Don't Read Too Much Into This Week's Action

Look for volume this week to drop back to levels normally only incurred during the week leading up to the Christmas holiday as most of the remaining market participants take off for the beach. It's difficult, and probably unwise to try and cull too much meaning from last week's and now this week's activity. Last week was more representative of traders trading with other traders than it was of actual supply and demand. This week should be more of the same. With this in mind, look for both breakouts and breakdowns to fail. Bet against meaningful price action and look for stocks and indices to bounce between support and resistance. With volume levels low, it will be easier to manipulate prices and gun prices temporarily higher to take out the short's stop losses. Likewise, it will be easy to drop prices below support and take out the stops for longs. We plan to be very conservative this week, only trading where we can see a very clear advantage to do so. Next week promises a fair amount of fire works; though the jury is still out on whether there will be a market breakout or breakdown.

Slow and Boring Trading with Slightly Negative Bias

On the long list of indices we tract, relative strength readings yesterday were all negative, save for the SOXX, semiconductor index. We would read this as more of an anomaly than an indication that the semis are about to show leadership. No, this market is set to drift, with what looks to be a slightly negative bias, through next week. Unfortunately this lazy end-of-summer trading is not likely to lead to much excitement until after Labor Day. We don't recommend getting overly aggressive since what we are seeing now is more representative of small traders trading amongst themselves than it is of real supply and demand. Yesterday, once again, program trading caused a slight rally in the last 30 minutes of trading. One respected analyst indicates that this "propping up" of the market into the close is having only the effect of temporarily staving off the inevitable.

Follow Through Lower is Doubtful; This Week Anyway

Sentiment has swung wildly back to overly bearish after yesterday's down day. Tech led the way lower but the semiconductor sector showed some resiliency, as did the S&P 500. Our scans today show a lot of bearish set ups and few reliable bull set ups. Nevertheless, we would expect to see the market bounce some today just due to the fact that bears are pushing too hard here. The reason that an overabundance of bearishness can cause the market to rally is not that complicated if you think about it. When the crowd is leaning one way, it means that they have committed their money. If the market fails to go lower due to the fact that all money that can be committed is already committed, bulls can gain confidence and cause short positions to start feeling pain. Once shorts start to get stopped out, their covering causes the market to move even higher. It's not really a question whether the market will deny shorts their sell off event this week. Shorts are likely to be disappointed if that is their hope. The real question is, is this market going to continue to experience serious distribution that quickly shuts down the rallies? If the 4-year cycle is going to take hold when the professionals return after Labor Day, then we should see more distribution and should see stocks struggle as indices near last week's highs.

Immediate Trend Nuetral

There isn't much to add to recent comments. Volume is low and the immediate trend is neutral. Bears are betting on an S&P breakdown, which could give it support, but bulls are betting on a QQQQ breakout, which should keep it below resistance.

Problems Remain with this Rally

Low volume, as predicted, has arrived. Yesterday was predictably a negative day, but selling never really took hold after an initial drop. We may see more backing and filling today and then could potentially see the market move back up near last week's highs later in the week. There are a number of reasons to distrust strength at this point. First of which is the fact that the bulls never experienced a capitulation event during the last downturn. Moreover, the market has rallied on below average volume. Most significant, however, is the fact that new highs have been sorely lacking. Stocks that rallied last week were weak stocks that rallied on short covering as shorts were squeezed. Significantly, stocks with strong charts trading near 52-week highs, failed to participate in the latest rally. Why is this important information? It means that smart money was willing to buy strength in expectation of the market making a strong bull run. The rally was then dominated only by short covering, which is indicative of a bear market rally, not the beginning of a new leg higher.

Let the Games Begin

Over the next couple of weeks volume should be very low as the pros head out for vacation. Last week's options expiration skews analysis and we will get some idea what real demand is this week, but emphasis should be placed on the word "some" since this week is certainly not going to clear up all questions. Real demand will not be known until the pros come back from vacation after Labor Day weekend. Look for games to occur in this low liquidity environment, with prices swinging widely against both bulls and bears.

Has Everything Suddenly Changed? Don't Bet on It.

All last spring and most of this summer, strength has been sold into. Early this week we had a similar situation, where the market had been trying to rally, but had been knocked back on each attempt. The market is often perverse though and once the pattern of selling strength was well recognized, it did the opposite of what it was projecting and gapped over resistance. Moreover, we have yet to see a real pullback in this trend. Readers will recall that we had a similar situation in May, only in reverse. In May, the market broke down from its long term trend and then traded straight down without one serious pullback. The QQQQ traded down $4.00 before it experienced a 50% retracement of the move. Now we have a mirror-opposite of May's down move and the QQQQ has traded up $3.50 from its lows, again without a pullback. Today is expiration day and a close near $39 on the QQQQ would cause the maximum amount of pain for the maximum number of options buyers as it would cause many of their put options to expire worthless; this after tremendous profits had been logged from the previous few weeks. Interestingly enough, $39 represents the QQQQ's 200-day average and a 50% retracement of the entire downtrend started back in May. In other words, there is some tremendous resistance at these levels. Getting back to lessons the market teaches us: the market taught us that it is good to sell strength, then, once the lesson was well learned, it perversely changed the rules. Do we now buy strength? We argue firmly, No! If the trend has changed, then we will see an orderly pullback from this major resistance level and dip buyers will be eager to get in. If the trend has not changed, we will see something of a panic ensue when dip buyers are not to be found. Today we should see the QQQQ trade near $39. A move slightly over $39 in the next few days is possible, but we would consider that a good opportunity to sell strength. A pullback from this area over the next few days to a week is about as sure a bet as bets go in the market. It is the character of the pullback that will be most telling.

Watch Profit Taking for a Clue on What Comes Next

Yesterday bulls got the numbers they wanted on the CPI release, allowing them to follow through on the rally started from the PPI numbers the day before. We are still shaking our heads over the failure of the strong bearish signal, which we outlined earlier in the week. In all the years we have traded, it's the first time we have seen this type of failure. Had sentiment figures been overly bearish prior to Wednesday, we would have discounted the set up. They were not. Today we will not try and make any new predictions, but will take a wait-and-see approach. Profit taking should start very near current levels. All indices are approaching major resistance levels. The question is, how will the market react to resistance? Will it reverse with a vengeance? Will it consolidate as dip buyers come in? At this point it's anybody's guess. We will abstain from trading until we get some better answers. It would have been wonderful to have had a crystal ball and to have been buying the ugliness last week, but it doesn't take a crystal ball to see that buying or selling at current levels is risky indeed. Especially with options expiring tomorrow.

Bulls Get Their Revenge; Will it Last?

The market continues to be very hard to trade. The short set up we had on the QQQQ yesterday was about as good as they come; perhaps too good. Perhaps the signal was so clear that the only thing that a truly contrarian market could do was to fade the signal. Or, perhaps the lower than expected PPI numbers released before the market yesterday gave bulls an unexpected opportunity to exact some pain from the shorts. The later is the most likely explanation for yesterday's surprise rally. The QQQQ is in a bear market and this rally does not change this fact. It is possible that when the CPI numbers come out today that they will compliment yesterday's PPI release and give the bulls more ammunition to put the bears in pain. As bears cover their shorts, the QQQQ could rally back up to major resistance at $39. This is the reality of bear market rallies. They are quick and painful and they reverse just as quickly as the stopped out bears can slap their heads and say "Doh!" ala Homer Simpson. Alas, we cannot argue with the market, we can only react to it. Should the QQQQ rally up to $39, we will short it aggressively. Until then, it is important to keep position sizes small and trade discipline high.

Why are the Bulls so Confident?

Commentators are nearly all barking in unison pointing to relative strength and good breadth on yesterday's rally. Bulls are sure that bears are leaning too hard and that bears are ready to have their comeuppance served to them on a platter. Bulls in fact are so confident of this that they purchased nearly 2 1/2 call options for every put option on the QQQQ yesterday (remember, anything over 2 is overly bullish). We can't understand it. Yesterday we posted a chart of the QQQQ and pointed out how the price has tried to break the downtrend twice over the past several trading days. Yesterday marked a third high volume rejection in just the last seven days. The bottom line is, this market has been very volatile and as hard to trade as any market we have seen. As such, we would not add any more to the short side here, but we certainly would be very hesitant to go long and we would certainly hold current short positions open.

Indices Trading at Resistance

We start options expiration week with sentiment in neutral and with tech indices poised for another leg lower. There are several reasons we think that tech has more downside left in it before it finally carves out some meaningful support. First, the downtrend is still in tact and with prices trading right at resistance levels, sentiment figures, as mentioned above, do not reveal a great deal of concern. Should the crowd be overly bearish here, we might be more inclined to look for a breakout that surprises the crowd, but this just isn't the case. Second, our scans reveal an abundance of stocks trading in bear flags with technical indicators that are overbought. This has occurred due to the fact that the market has bounced softly in relief from the last down leg, which has put many stocks right up against their falling 50-day averages. Pros enter trades at the 50-day average. Finally, the QQQQ has made two recent attempts to break the downtrend, but was rejected on both attempts. Moreover, volume on the rejection days exceeded volume on the subsequent recovery days by a margin of nearly 2:1. Note the chart below. We have highlighted the rejection days and have drawn lines connecting the volume bars representing those rejection days. It is clear that distribution continues to exceed accumulation at this time. Understand that no one can possibly know what the market will do next. All we have to rely on are probabilities. It is important to short when it is scary to do so; when stocks are trading up against resistance and when you are afraid that resistance will be broken. Just like it is important to buy at support when everyone is worried and when your own emotions are telling you "don't do it, support might break." Why? Because it is at these times that probabilities are most strongly in your favor.

Yesterday's Rally Lacking

By now the market is trained to buy any weakness related to terror events. Despite the fact that the market is in a precarious position here, programs kicked in and bought the gap down yesterday and prices closed near daily highs. Wanting on the recovery was significant volume. Likewise, the move just pushed the indices up near resistance levels once again. We will be surprised if there is much follow through from yesterday's move. We would be much more trusting of a rally effort if the market would pull back down near recent lows to regroup and shore up support. We are not seeing any decent long set ups and short set ups look very good here. However, there is some concern that we will get a bit of an overly exuberant follow through rally, which while doomed from the start, could put our shorts in jeopardy of stopping out before the market reverses again. This is why we recommend keeping position sizes small in this market. Program trading has played havoc with position traders on both sides of the trade lately.

Trend Reasserts Itself

Fears about the economy proved to be too much for the bulls yesterday. Their last attempt at breaking the market's downtrend failed and they are likely out of firepower to lift prices higher from here. This puts the lows from July into jeopardy. Don't fight the trend here. Now is the time to be short this market.

Traders Sell the News

The pause in rate hikes sparked a very minor rally before prices took a sharp plunge. This shows that the downtrend is firmly in control and that lower prices are to be had before we get a significant bottom. Nevertheless, QQQQ bears are a little over confident and are leaning too hard one way. The put/options ratio shows that we should get something of a bounce today. The day after the Fed meeting, stocks generally reverse much of the previous day's activity, so it is likely that today will see some price relief from yesterday's sharp move lower. Since the downtrend is still in effect, today's expected strength should help set up better entry points for taking on new short positions. Most stocks remain technically overbought and any strength should be used to open new shorts.

Looking to Fade a Potential Fed Rally

Today the Fed is likely to take a pause on rate hikes. The market expects this, but such an event should spark a quick rally nevertheless. Unfortunately a pause at this stage is not going to clear up the worries that this market has in front of it. A pause this time does not take away the question about whether or not the Fed will choose to pause next month. As such, any quick rally after the release – or prior to the release in anticipation – is likely to be quickly sold. Indices and stocks alike are now technically overbought and rallies are generally sold when this is the case. Due to this long string of rate hikes, there are strong indicators pointing to a recession next year and the market knows this. The only scenario that might spark a legitimate rally would be an actual lowering of rates this round as it would indicate that the Fed is concerned with the health of the economy and the market. From what we can gather, however, it appears that the Fed is more interested in fighting inflation in the commodities sectors than it is in the current stock market outlook. This is why, we believe, stocks are projecting more downside.

Fed Meeting Looms Large

On Friday all major indices gapped up and then sold off the remainder of the day. Late in the day buyers started to come back in, but this could have been daytraders taking profit on their short positions. This sets up an interesting situation. The tech sector is overbought and has now sold off at resistance. There has been no evidence of accumulation and ideally, this is a perfect short set up. The problem is, tomorrow the Fed meets and tomorrow's meeting is perhaps one of the most important events the market has had to look forward to in some time. The yield curve on long term bond rates has now firmly inverted, threatening a recession late next year. This puts some pressure on the Fed to pause. The question is, is the Fed interested in avoiding a recession, or do they have something else in mind, such as putting the brakes on the world economy to get oil prices back into line? If the Fed takes a pause tomorrow, as it is expected, then the oversold condition of the indices is likely to move up to even more oversold as prices rally in celebration. We will probably short such a rally, but will need to see what the charts look like after the dust settles. If the Fed raises rates again, it would probably be very bad for stocks and we could see a sharp down day, for as we mentioned, stocks are ripe for a slide already.

Jobs Data Will Lead the Way Today

The market rallied back to resistance yesterday on a bet that today's jobs data will be weak enough to render the Fed with no alternative but to stop their rate hikes during next week's meeting. The problem is, market leading indices, including the QQQQ and SMH, were pulled along for the rally as opposed to having led the way. Accumulation indicators on these two indices have stayed flat even as the price has moved higher, indicating that smart money has not participated in the rally. There is a potential that the jobs data will propel indices higher today, perhaps even pushing them over resistance. We hope that this will not occur however. Capitulation, which is needed to mark a clear market bottom, is strikingly absent and any rally higher from current levels will be performed on very little buying fuel setting the market up for another extreme wave lower. It would be much better if indices turned back here and worked on building a base of support before they rally above downtrend resistance. We can't tell the market to do what we want it to do though so for today, we will wait and see what develops after the jobs report to be delivered before the market opens.

QQQQ Should Test Resistance

The tech-heavy NASDAQ continues to diverge from the blue chip S&P 500 and Dow indices. Until tech starts to lead the way, any move higher in the blue chip sector should be viewed with suspicion. We are operating under the theory that the NASDAQ, which has been the market leader on all rallies over the last few years, maintains its leadership role. As long as this leader is diverging bearishly against other sectors, the downtrend must be respected and strength must be faded (sold into). There is some evidence of accumulation in the small chip indices indicating we are in the middle of a basing cycle and not a distributive one. Nevertheless, it appears quite likely at this time that we will see the QQQQ head back down to its lows at least once more before it finds enough strength to make a break of its immediate downtrend. We do expect to see buyers continue to buy over the next few days lifting indices slightly higher. We suspect, however, that smart money will be using this as an opportunity to reload their short positions. Look for the QQQQ to test $37.40-$37.60 over the next day or two.

Bear Trap Being Set, or the Real Thing?

The QQQQ gapped down and led lower yesterday after a low volume rally up near resistance. The question is, is this a bear trap in the making? QQQQ shorts are buying 4 times as many puts as bulls are buying calls. With bears leaning one way so hard it seems unlikely that yesterday's sell off will gain much follow through momentum. Likewise, yesterday's gap lower is probably more bullish than bearish at this stage. Bears are getting overly exuberant while weekly charts are very oversold and due for some relief. It wouldn't take much to spark a strong relief rally and with the Fed possibly acting next week, this may be the spark that bulls are waiting for to challenge this latest sell off. It might be a better idea to start thinking about buying weakness as opposed to selling it.

Lead Dog QQQQ Still Leads Lower

The QQQQ found resistance at its pivot point (middle of the downtrend channel) and turned sharply lower yesterday. This created a bearish engulfing signal, and as the name implies, it is bearish. Since the QQQQ has been the market leader on this downtrend, it will also be the best indicator of when this downtrend is ready to provide a significant relief rally. We have had a few teaser rallies over the last few weeks, but nothing that lasted more than a few days. We suspect that as the QQQQ reaches down to its lows, and perhaps even makes a new low, that sentiment levels will once again reach extreme. We also suspect that we are very near a strong relief rally and that buyers will be soon stepping in to the consternation of overly confident bears. This is still a market to be short in, but it is also a market for the nimble. Next week we may have an opportunity to participate in a strong upside move if we can get the right mix of decent earnings reports and too many bears with their hands in the honey jar.

Tech May be Forming a Bottom

Breadth in the tech sector was good yesterday, indicating that we may be nearing a bottom. However, buying power has likely been used up in this latest rally off the floor, making it likely that the QQQQ will see a return to its lows before it can move significantly higher. If however the QQQQ insists on trading up back above $37 without a significant pullback to help it establish a better base, we will be forced to start shorting again as a move higher from these levels will be unsustainable.

Yesterday's Rally Likely to be Short-Lived

Yesterday's follow through day has a lot of bulls thinking recovery. The problem is that indices are once again near stiff resistance. It's not a good idea to make too much about yesterday's trading. Buyers could potentially come in and buy stocks up past support, but the probabilities are slim that this will happen. Moreover, without a decent base from which to rebound, a move higher is likely only going to attract more sellers and cause another steep drop.

Recovery Effort Weak Thus Far

Sentiment did indeed keep a floor under the market yesterday, but the bounce has thus far been uninspiring. What we are seeing so far is more indicative of consolidation as stocks work off their oversold conditions by trading in a narrow range than it is of a recovery effort. After such a steep sell off, we are quite likely to see at least one more wave down before sellers decide to take profits and buyers find the nerve to reenter the market in force. Our projections show that we could see the QQQQ drift slightly higher over the next week or two, while the blue chips trade in a sideways range. Unless we see serious volume come in and see an upside breakout that sticks in the blue chip sector, we need to call a club a club and admit that we are still in a downtrend. What does that mean exactly in practical terms? It means that rallies should be sold and that stocks should not be chased.

Overbougth Levels Could Spark a Rally

Sentiment levels are nearing all-time-high bearish levels. This should keep a floor in the market at current levels. It is also interesting to note that oversold levels and the weekly trading patterns in the QQQQ are now nearly identical to the week of August 9, 2004. If indeed we have a bottom in place, a rally out of this hole could potentially be quite significant. The tell will be how strong the bounce is. If the market fails to bounce and/or it bounces weakly, we may be looking at more downside. If we can get a good broad market rally on good breadth this week or next week, then we may be in for a very nice recovery. To be sure, it is too late to short in all but a few sectors.

A Better Oversold Rally is Nearing

Options expire Saturday so expect more meaningless trading today as options sellers attempt to work stocks into their maximum pain points. The QQQQ dropped lower once again yesterday, but frankly we wouldn't trust a breakdown at these levels. A break lower is likely to lead to a strong intraday reversal and should signal the beginning of a decent countertrend rally that will last more than just one day. Gold has done a fairly good job confirming that a top is now in and so it should be considered to be trading in an intermediate downtrend now. Any bounces should be sold into in this sector; baring off course a strong reversal due to a serious erosion of Middle Eastern stability (unlikely). Likewise, oil stocks are continuing to experience real pressure, even as the price of oil holds above $70. We wouldn't short oil here, but we would avoid buying it at this time.

Yesterday's Bounce Likely to be Short Lived

Yesterday was likely the only day that it was safe to enter for an oversold bounce. The trend is still down and the market leaders, QQQQ and SMH were both essentially just pulled along in yesterday's rally; as opposed to leading the way, which is what the market leaders should be doing if this recovery were legitimate. Ideally we will see the QQQQ come back up to just above $37 before it finds resistance again. It has room to vacillate for a few days before running into the downtrend resistance line, as you can see in the chart below. With options expiration on Saturday, that is exactly what we would expect the market to do; vacillate with a slight upward bias. It is best not to get overly aggressive in front of options expiration. Price movements will be less meaningful over the next two days. Settle in with your open positions and wait for stocks to bump back into resistance for a good set up.

Tech May be Ready to Run

The tech sector is close to staging a bounce. Negativity in the sector is at overly bearish sentiment levels and technically the sector is very oversold. It's not reasonable to look for more than a counter trend rally at this time, but a rally in tech could potentially run strong for a few days and is worth buying a few shares to participate in it.

Significant Low May Occur Next Month

World events are creating artificial conditions for a steep market sell off. These events have an artificial impact, because the correlation between the US economy and events in the Middle East, is somewhat dubious. Nevertheless, we have been looking for a significant market bottom sometime later this year, but with the perception that risk must be priced into the market based on unsettling world events, we may in fact get a significant low as early as the next few weeks. The four-year cycle low, we wrote about yesterday will still likely put pressure on the rebound from our upcoming significant low, but with this hard sell off, the four-year low could actually come in the form of a double bottom or even a higher low. In other words, we are very likely nearing a long term buying opportunity. For now though our focus must remain on what is right in front of us, not what could be around the corner. For now the immediate trend is down and this will impact the performance of most stocks in the market. Rallies are likely to get sold and oversold will likely continue to become very oversold until we see capitulation. When will capitulation come? It will come when it comes, no sooner, no later. It is best not to try and guess, but rather to trade with the trend.

Relief Bounce Likely, But Not Likely Sustainable...Yet

The market is oversold and due for a relief bounce. Keep in mind that any relief bounce should be shorted into at this point. Investors who were late exiting before this latest leg down in the sell off will be looking for better prices to exit. This will keep pressure on the market. Right now the market is in a confirmed intermediate downtrend. Until genuine capitulation takes place, the best policy will be to use the rallies to enter short positions. Currently we have a hypothesis about how this downtrend will play itself out. The QQQQ is trading in what looks to be a measured move pattern at this time. This means that the current leg down should run in equal length to the last leg down, from $42.00 to $38.50. Using the measured move hypothesis, we should see the QQQQ trade down to $35.00 before a sustainable rally can ensue. $35.00 also represents the next level of weekly support. Once a sustainable rally gets moving, it is possible that we could see a strong move up over the next month or two, perhaps even moving so far as to tag the broken support line at $39.00. Now, keep in mind that the 4-year cycle low is expected somewhere around November of this year. Thus, after the next sustainable rally (not to be confused with an expected one or two day bounce we are looking for this week), the market is likely to turn down again heading into November. November is expected to mark a significant buying opportunity for long term buyers. The trading opportunities heading into the 4-year cycle low should be nothing short of fantastic. Today we recommend not entering any new positions while we wait for the market to work off some of its oversold conditions. A lot of Friday's selling was an unwillingness to hold over the weekend in face of the ME crisis. Pressures should abate some as we start the new week.

Ignore Any Bounces, This Slide Has More Ways to Go

Once again options traders are overly bearish. Yesterday's instability in the Middle East forced the market lower despite the overly bearish posture amongst the masses. Nevertheless, we should see a bit of a floor today, if only a temporary one. The market is confirming the 39-week cycle low, which is projected to land toward the end of the month. It is doubtful that we will see a meaningful reversal until it lands. Any strength in the interim should be aggressively shorted. The strange thing about yesterday's market was the sudden disconnect between oil stocks and the price of oil. With oil soaring past $78 overnight though we should see strength return to this sector today.

Tech Weakness, but Too Many Bears Make a Minor Floor

Options traders on the QQQQ are overly bearish, so we should see some of yesterday's weakness reverse today. Nevertheless, the tech sector is weak due to fed bank policies in Japan and fears of further weakness do not appear to be going away anytime soon. As such, institutional money will probably keep on selling the rallies as they seek to sell down their inventories to the sleeping point (the point which they can sleep easier). The market is really in a state of indecision at this point. Selling pressures have abated somewhat, but buyers are certainly not rushing back in. There remains a lot of uncertainty related to future rate hikes and upcoming earnings. We would continue to short bounces in tech and consider a few longs in commodities. Cash is a good place to be heavy in though until next week when some of the question marks overhanging the market find resolution. Technically one of the bigger question marks is will we get a bounce prior to a hard move down into the expected 4-year cycle low, or will the market drift and then plunge, or will we get a tradable rally that then sets up for a bigger drop. With such widely contradictory possibilities, it makes sense that the market is confused right now.

Shelf of Distribution

In yesterday's report we outlined our thesis arguing that the market was under extreme distribution, but that shorts would likely be shaken out of their positions before the market turned significantly lower. Yesterday's late afternoon rally fits the thesis and if we are right, we will see the QQQQ rally sharply higher over the next few days to fill the gap near $38.90. The pros call this process "creating a shelf of distribution." It is to the benefit of institutional money to exit their positions at higher, rather than lower prices. If they can get the market to work its way higher buyers will create their own self-perpetuating momentum. This type of trigger tends to exhaust itself quickly since smart money uses the momentum to sell into. There continues to be evidence of distribution as money flow figures on some major sectors are turning down as prices turn up. Using this momentum to sell into appears to us to be the highest probability play. Understand that we, or anyone else, do not actually know what is going to take place in the market. The market is all about probabilities. Our work shows that the highest probability play will be to sell into this minor rally we expect will take place over the next few days. If we are wrong we will see stock set ups start to improve. The downtrend is still in effect and there is no money to be made in calling an exact bottom. If the trends turn back higher, there will be plenty of time to go long again as stocks back and fill to build support. It will be interesting to see if the market can rally sharply higher today the way it did on 6/15 and 6/29. Note the fact that after those two rallies distribution took place and no real follow through was realized. There does not appear to be any sense in grabbing long exposure for a one day rally (if it is to play out like this yet again). We will do better to sideline ourselves today and look to see what develops today and perhaps tomorrow. Options expire on Friday, making any rally equally suspicious at this juncture. The bottom line: This market is not providing high probability set ups and due to its one-day-up, one-day-down nature, the chances of getting whipsawed are very high.

Market Correction Setting to Continue

At the end of June the S&P 500 and Dow both rallied strongly over their downtrend lines indicating that the market correction had played itself out. Unfortunately the NASDAQ was not able to rally quite so far and while the blue chip indices have been holding up, the tech-heavy NASDAQ has been bleeding off. Likewise, the lead tech sector, the semiconductors, has proceeded to break down to even lower lows. All last spring the tech sector led the market lower as it underperformed. Now it is once again underperforming and the fact that we have not seen a strong follow through rally develop indicates that the market recovery attempt has failed. A slew of stocks continue to trade at 52-week lows and bounces have found distribution over the past few days. There is some indication that we will see one more thrust higher. The QQQQ has an open gap at $39, which could possibly fill. Likewise, it seems unlikely that the QQQQ will follow through lower after 4 days in a row of downside already at its back. The scenario we see possibly developing then is a sharp up move, which would stop out overly eager shorts, followed by a crumbling downturn. Due to the amount of distribution we have seen over the past few days, a downturn now could leave the market grasping for a floor only to find an air pocket below. In other words, This is a market for traders and traders should probably be easing into short positions on the bounces. Those holding intermediate long term positions should probably be in cash at this point.

4th of July Rally Fails to Garner Buying Interest

The lack of buying interest this week has been troubling. Equally troubling is the continued underperformance in the tech sector. This is exactly the same picture we saw in late spring of this year before the market took a turn for the worse. Since the market has not made a strong recovery off the recent lows we can only assume that the downtrend started in May is still in effect. Today's employment report is expected to come in with large numbers. The market will likely react harshly to a "good" employment report as they expect that the Fed will be forced to continue raising rates. The problem is that rate hikes have already impacted the outlook for the economy in 2007 and raising rates more will likely turn a soft landing into a hard landing. The market knows this and is panicky. We would like to start adding some short exposure, but with the big looming employment report to be released before the open today, we are unsure how the market is going to react. It is unlikely to correct the fact that the market is going to correct further over the next week or so, but today's reaction could certainly skew our entry calculations making it more likely that we would stop out of a good position.

Tech Underperforms Yet Again

Tech continues to under perform, just as it has over the last six or more months. It's early to determine if this is going to have a negative impact on the strength of the latest rally, but this is not a great way to start. The QQQQ pulled back much more harshly than the S&P 500 ETF (SPY). Now the QQQQ has met the mid point of its Bollinger bands, a point that will help mark whether sellers are serious or whether dip buyers are ready to come back in and rescue the tech sector from a retest of the low. The problem with a retest of the low would be that it would do a great deal of technical damage to the weekly chart. By our rules it is important that the QQQQ hold up at Friday's close or we may be looking at another leg lower in the market.

Market Overbought; Pullback Watch

The market was surprisingly strong on Monday but indices are over bought and prices are due to retrace some of the recent profits. QQQQ traders are overly bearish so this sector could maintain some support today. Nevertheless, prices at least need to trade in place for a few days to work off some of the recent overbought condition. We are looking for gold stocks to retrace most of their recent gains. A pullback in this sector should be considered a buying opportunity. Likewise, oil looks to be headed for $85 so while a pullback in sympathy with the broader market is probable, the pullback should come on lighter volume and produce a buying opportunity among the drillers as well. Today we are watching a list of oil stocks to get a better entry measurement. We would like to add oil to the portfolio, but want to see how some of the stocks perform as the traders come back from their long weekends. Keep an eye on ENG today as this will be one of our top choices.

Short Day Today

At the close on Friday program trading kicked in and a large number of stocks experienced distribution or accumulation. At this point it is difficult to determine. Technically indices are overbought and the 50-day average on the QQQQ could be problematic here as this major market indicator moved up to tag this level before selling down on Friday. This week we could see consolidation where stocks trade sideways or we could see stocks retreat and move back down to test recent lows, keeping the three-week trading range in tact. Oil and metals stocks continue to outperform and pullbacks in these sectors should be considered buying opportunities. We need to be careful with the broader market however until it proves itself. Again, program trading on Friday skewed our recent analysis and that data that we had interpreted as bullish is now in question. Today the market closes early and it will be closed tomorrow. Most traders have taken a long weekend and will not return until Wednesday. We recommend that everyone do the same. It is unlikely that anything meaningful will occur in today's market.

4th of July Rally Kicks Off

Right or wrong, institutional money bet on an end to rate hikes yesterday. In yesterday's report we outlined the similarities between Wednesday's market sell off and the down day on October 27. Now with the market up on big volume and the fact that the market never truly followed through lower after the June 8 capitulation day, the chances of a strong rally similar to last November's is quite high. Continue to manage volatility as this market can still shake people out of good positions, but consider accumulating aggressively on dips.

Indecision Rules Before Today's Fed Meeting

Scans today reveal that a very large number of stocks have moved up to tag the under belly of their respective 50-day averages. Meanwhile the major indices have yet to break their downtrends and are trading very close to resistance. Overly bearish sentiment kept a floor under the market yesterday but now we have extremely mixed readings. S&P options traders are extremely bearish, having purchased 4 puts for every 1 call option. QQQQ options traders on the other hand are getting a little too bullish once again. What we have here is a market that can go either way. Either stocks are going to break their respective downtrend lines and start moving back up in a continuation of the relief rally, or we are on the verge of another leg lower. The problem we face today is that virtually no one knows what is going to happen. The market is going to turn on today's Fed meeting and fireworks after the notes are released are probable. Doing anything in front of this meeting with this type of market set up is a gamble that will very likely not pay off for anyone. We would not be at all surprised to see the market move wildly one direction at the time of the Fed release, only to swing back wildly in the opposite direction as the comments are parsed and digested. Bulls and bears are both likely to get burned in the storm so it is our advice to just step back and stay away. We have some open half-sized positions. At this time it is best to just keep open position sizes small allowing for flexibility to react once the dust settles and there is once again an exploitable advantage. Oil stocks and some of the metals have thus far been holding up better than the broader market. It will be interesting to see how these sectors respond to the Fed today.

Gloom and Doom Spells F-L-O-O-R

It feels like we have been in a deep bear market sell off during the month of June but the truth is the market has virtually gone nowhere since it marked what we considered a capitulation day on June 8. Yesterday's sell off simply brought stocks back to the bottom of the current trading range and in doing so inspired hapless options traders to once again take an overly bearish stance. For the first time in weeks both OEX and QQQQ options traders are in agreement. They agree that we are going to correct lower to the tune of buying more than 2 put options for every 1 call option. As our long time readers know, when this group of traders leans too hard one way they are almost always wrong. In fact the accuracy of their bad market calls has proven to be a very reliable reversal indicator. During this 6-week sell off the QQQQ cut through its 200-day average like a knife through butter, not even slowing down to take a rest. In our experience over the years bulls just do not give up on the 200-day average so easily. There were extenuating circumstances as the Japanese equivalent to the US Federal Reserve raised rates last month causing heavy institutional speculators to pull out of their huge metals and oil positions last month causing a world-wide market crash. This in turn caused the waterfall breakdown that forced the US investors to sell down to their comfort levels. Now however as things look ever so gloomy and the market looks to break down to another new low we think there is a very good chance that many will be surprised as the market rallies hard and regains the broken 200-day average on the QQQQ. Note the similarities between yesterday's sell off and October 27, 2005. With bears overly exuberant and with everyone scared, it will be interesting to see if the market does indeed once again surprise the greatest number of people and rally. Today we would like to see a consolidation day. This will give us time to evaluate which stocks to buy and which to avoid.

Gearing Up for 4th of July Rally

We continue to experience wide daily price swings making it necessary to scale into our trades in pieces. Buying smaller shares sizes provides us with several advantages. First it provides flexibility, allowing for us to add on shares once the market provides more information. Second it allows us to move our stops out wider so that we don't get stopped out on market noise. We believe that these and other advantages far outweigh the small increase in brokerage fees. We are nearing the end of the month when trading advantages are strongest and where we generally see a rally due to an injection of new money into the market via retirement funds. This month we could potentially see a stronger rally than usual. The fourth of July rally is a cyclical rally that often arrives as pressures from the "sell in May and go away" culminate into an oversold condition that produces a mid summer relief rally. This year the factors are all in place for just such a rally to ensue. We may see some weakness in the beginning of the week, but we plan on using any potential weakness to accumulate.

Time to Start Buying Dips

There are many tried and true rules related to investing and trading in the stock market. One of these rules is "don't try and catch a falling knife." Contrary to this rule is the strategy of buying the dips. Buying the dips seems to contradict the rule of avoiding falling stocks, so which is it? Well, the answer is that there is as the Ecclesiastian noted, there is a time for everything. Buying dips at the end of May certainly turned out to be the wrong thing to do as the month of June started out with a waterfall-type slide that crushed the bulls. Now the major indices have returned to the downward sloping resistance line that turned stocks back early this month. We are very likely to get another slide back near recent lows. This time we argue however that the time has come to buy the dips. Why? Because there is evidence that smart money is already buying them. Money flow figures have been rising even as the market has been under pressure this week. We are very likely going to get some strong downward moves over the next few days that will shake loose the weak hands, but the way that smart money is now positioning itself we will be looking for a much stronger rally to ensue toward the end of this month. The bottom line is that now is the time to be buying the hard dips and avoiding strength. Use a scaling entry strategy because we don't know where the market will bottom. Recent lows may be tested or the market may bottom slightly lower or slightly higher. Europe is already showing signs that it is ready to move higher. We believe that metals will lead the way in the US markets. Again, don't chase what's going up, but begin to nibble at what's going down.