A Chemical Romance

The chemical sector continues its interesting journey, all but ignoring bear market pressures that took down even the strongest of groups. Now, once again, these stocks are back at 52-week highs and knocking on the door of resistance like a DEA agent with a warrant in hand knocks on the door of a suspect.

Today we will take a look at some of the leading stocks in this sector, we'll look to see if there are any chinks in the armor of the massive uptrend they are enjoying and look at a couple of scenarios that might play out over coming weeks.

Starting with Celanese Corp (Ticker Symbol: CE), note that the stock has formed a strong base of support above its rising 10-day average. After a short trip below the 200-day average, the stock has recovered in V-bottom fashion and the 50-day and the 20-day are rounding back up again.

Major resistance hovers just above in the $42.00 area so the stock may stay hemmed in for a while, but the bullish outlook for this stock continues to be promising.

Next, we will take a look at Monsanto Co (Ticker Symbol: MON). MON broke its trend when the market plunged in January, but has since recovered strongly and is now testing the underside of the uptrend. It too may be hemmed in for a while in this area, but the trend for MON is such that it would be foolish to short hoping to catch the top here.

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We would look for one of two scenarios to unravel here. If the market can power higher from current prices, look for MON to test and probably take out its 52-week highs. If, however, the market moves back to January lows for a retest, MON may tread water or pull back slightly for a period of time.

Finally, let's take a look at MOS. Today MOS is breaking out to a fresh 52-week high on volume. Unlike CE and MON, MOS never breached its trend on a closing basis. Undoubtedly this is a strong stock as can be seen from the weekly view below.

There is one chink in the armor that we would point out. Money stream (the pink line in the chart below) has diverged bearishly against price. This isn't a deal breaker and we've seen a divergence like this heal itself. It does tell us that the stock has a bit of a cough and if it doesn't take care a cough could potentially turn into something worse like a case of pneumonia. There is no reason to sell here and no reason to panic. Just be aware that signs of weakness are starting to show up. As long as more symptoms don't appear it should be ok.

Stocks Remain Range Bound

The SPY, and all other major indices, continue to trade below all major moving averages. On Thursday prices threatened to roll over out of the near term uptrend and in fact they did on Friday. Selling on Friday wasn't spectacular, however, and the selling was quickly contained. We would consider the day essentially a draw between sellers and buyers.

Technically the market is projecting a retest of January's lows. Technically traders should be short here.

That said, we aren't sure that the message sent by the technicals is reliable here. European markets rallied hard yesterday while US markets were closed. It remains to be seen whether the US market will follow today.

The bottom line is that the market remains range bound. There are two key areas to watch on the SPY. A close above $136 would break overhead resistance and would project a run up to $142+. A move below $131.50 would be a breakdown and would project a retest of the lows.

We would be strong buyers if the price were to move back into the $126-$129 area again. Such a move would constitute a low risk buying opportunity.

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Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

Bearish Engulfing Candlesticks Abound

Yesterday the market, represented by the SPY chart below, sold off at resistance creating a lower high and a bearish engulfing sell signal.

This sell signal was repeated en masse on stocks across virtually all market sectors.

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Explanation:

Near term sentiment isn't bullish enough to provide support and with yesterday's sell signals the market may be headed for a retest of January lows again. While we continue to look for a run back up to test the 50-week average, we can't ignore the weakness that exists on the daily chart view. A sell signal is a sell signal so it makes sense to take a short position here as long as good tight stops are used should this just be another market misdirection. Risk remains high, so keep your exposure to a minimum.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

It's Best To Wait For A Dip

Prices rose yesterday but volume was muted. If you were smart enough to buy the SPY in the 132-133 area, then continue to hold. Otherwise, there are just no advantages today, this Thursday in front of tomorrow's options expiration.

Near term sentiment has turned bullish, so a dip that threatens to retest recent lows is likely. Considering the fact that long term sentiment is extremely bearish, buying the next dip would be the wise move. Today the wise move is to sit on one's hands and wait for the dip.

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Explanation:

Near term sentiment flipped back to bullish yesterday. However, volume on the upswing was weak across the board. Prices could theoretically keep moving higher without a pullback, but the odds support a strong likelihood that prices will pull back and build a better base before a true rally gets underway.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

Overly Bearish Market Supports Higher Index Prices

Scans today offered up mostly short positions. The QQQQ is just plain ugly here as are stocks like AAPL. Oil stocks are in a dead cat bounce that looks to have run its course.

Even so, the near term trend in the SPY is up and sentiment is overly bearish. This supports a blue chip rally at a minimum.

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Explanation:

Bearish sentiment supports a rally here. However, weaker sectors, such as tech and oils, offer potential shorts here. Either way, we recommend shorting only a very small position and if you go long, try to stick to index trades as individual stocks are unreliable here.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

It's To Your Advantage To Heed Risk

Today we would like to address the reasons why risk is such an important consideration to take before putting money to work in the market and where the advantages are best.

Over the past few weeks we have noted that risk has been extremely high. This has been represented in the SRS Risk Assessment Meter. But today, let's take a look at precisely why risk is high and why it is not a good idea to have much, if any cash working in this market. We will also take a look at what a low risk situation looks like and why putting cash to work has a better chance of success when risk is lower than it is now.

As you can see on the chart below, the SPY, which we are using as a representative of the broader market, is currently trading at its pivot point:

After putting in a panic low in late January, the market has pulled back to the pivot point where it is struggling to make a higher low. Due to the fact that sentiment is extremely overly bearish and due to the fact that technical indicators point to a low level of buying here, not to mention the fact that the Fed continues to be a factor, odds slightly favor a move back up to the falling 50-week average.

The key word here is "slightly."

Buying is extremely weak at current levels and volume has been shrinking. While odds slightly favor a rally back up to strong resistance, a breakdown below last week's lows has some potential as well.

If the market can muster a rally, the number of stocks that will come along for the ride is likely to be small since the market is in a major downtrend here and any upside would only be a dead cat bounce against the larger trend. As such, trades taken in this area are prone to a high failure rate.

Where Risk Is Low:

One of two things will happen over the next week or two, which will give us a better trading opportunity than currently exists. The market will either break down and give us a good low risk buy entry as panic spikes once again, or the market will weakly rally into overhead resistance, giving us a high risk shorting opportunity.

The lesson here is that if you refuse to put good money to work during times of high risk and patiently wait for prices to move into the zones where risk is much lower you will not only avoid letting your trading account get chewed up by too many stop outs, but you will easily outperform the averages and more than likely blow away the star fund managers who feel obligated to have their money working in the market at all times.

Independent Trader Advantages:

As small, independent traders, you have an advantage over the big money managers in that you don't have to have your money working during times of high risk and you have the ability to move in and out of positions quickly as conditions change. This is an outstanding advantage that most traders fail to use. We strongly urge that you use this advantage as doing so can make the difference between below average returns or results that would make a Buffet proud.

Explanation:

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With sentiment bearish and with prices near support levels, we are looking for stocks to rally back up from near current levels. As noted above, it's hard to justify buying when all major moving averages are still pointed down, but we wouldn't want to be very short here either. In fact, it might be a good idea to put a toe or two in the water (using tight stops of course) here in some of the stronger areas of the market.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

A Tradable Bottom May Be In Place - But Be Careful

The QQQQ has now found support at its 5 year trend two weeks in a row. The SPY is trading a meager 1% from weekly Bollinger Band support. Bollinger Band support is unreliable when downward momentum is strong, but momentum has stabilized so we believe that this support level will hold here.

While technically prices are oversold and at levels where we would expect them to find support, talk of recession has reached near fever pitch in the media. People who have no experience in the markets and no viable knowledge about the economy are talking recession.

With bearish sentiment so high and with stocks at support we have to believe we are very near a tradable bottom. We can't justify jumping in and buying yet; not with the 5, 10, 20, 30, 50, and 200 day averages all trending down. But, we would certainly want to keep stops on shorts very tight and we would be putting together a wish list of stocks to buy when the market turns the corner and the 5- and 10-day average turn back up again.

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Explanation:

With sentiment bearish and with prices near support levels, we are looking for stocks to rally back up from near current levels. As noted above, it's hard to justify buying when all major moving averages are still pointed down, but we wouldn't want to be very short here either. In fact, it might be a good idea to put a toe or two in the water (using tight stops of course) here in some of the stronger areas of the market.

Outlook:

The rebound rally back up to the 40- and 50-week averages we have been discussing will likely occur sooner rather than later. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

On Day Up Does Not A Bottom Make

We warned that whipsaw risk remained high and yesterday we saw how this risk could come into play and murk up the situation.

Realistically there are few advantages in this market. It is oversold, but still trending down. Yesterday's high volume bounce was interesting, but it didn't break the downtrend. Moreover, scans today once again revealed very little to work with.

Right now short positions are risky as this oversold market has the potential to turn on a dime and squeeze shorts hard when sentiment turns overly bearish like it did yesterday following a poor CSCO earnings report. At the same time, until we get a follow through day to the upside and a better base to buy off, buying this market is even riskier than shorting it.

The only reasonable thing to do here is to stand aside and wait while big risk takers allow their accounts to get ground up in the day-to-day reversals.

Explanation:

Long term, the market is in a confirmed downtrend.

The market is getting jumpy and is likely close to a tradable bottom. But, until we get a follow through day, this market should be considered guilty until proven innocent.

Outlook:

Prices may test recent lows; especially in tech. However, we continue to look for a rebound rally back up to the 40- and 50-week averages at some point over the next few weeks. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

QQQQ Tests Its 5-Year Trend Today

The QQQQ is threatening its 5-year trend line. It could potentially break here but it's not a good idea to press short positions until there is a confirmed break down. If the QQQQ breaks down, there is always a possibility that the Fed will jump in with another rate cut.

Today we recommend tightening up short stops. Likewise, if we get a panic sell off this week and the SPY moves down to 125, it might be a good idea to fade the dip by buying fear in the banks, real estate, builders, retail and perhaps even the semiconductors; all of which are vulnerable to more short squeezes.

On the other hand, if prices continue to just bleed lower, like they have for the past two days, this decline can continue unabated for some time to come.

More importantly, keep position sizes small, be quick to admit if you are wrong, and keep a good cash reserve that you can put to work when risk levels decrease.

Game plan summarized: Stay short, keep stops above your entry points, and if the market panics and washes out, consider buying small positions into the panic. A wash out would constitute a quick SPY move down to $125.

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Explanation:

Long term, the market is in a confirmed downtrend.

The near term trend turned lower once again yesterday. However, note that sentiment has once again moved into the overly bearish area.

Due to the fact that there are several levels of support currently being tested, risk of a short squeeze reversal is high. Likewise, the Fed continues to be a factor. If the market threatens to plunge again, they may be ready to throw in another big rate cut.

Outlook:

Prices may test recent lows; especially in tech. However, we continue to look for a rebound rally back up to the 40- and 50-week averages at some point over the next few weeks. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

Market Turns Down Again, But Shorts Should Remain Cautious

We would remain mostly in cash here. Oils and some big cap tech offer compelling short set ups, but potential for whipsaws and short squeezes remain high; especially in the financial and builders sectors, which benefit from recent rate cuts.

Explanation:

Long term, the market is in a confirmed downtrend.

The near term trend turned lower once again yesterday. However, note that sentiment has once again moved into the overly bearish area. Likewise, volume was not spectacular so shorts that press may end up getting squeezed on a mid day reversal again.

There are some areas that offer decent short set ups, but we recommend keeping position sizes small and be ready to exit quickly if prices once again find support.

Outlook:

Prices may test recent lows; especially in tech. However, we continue to look for a rebound rally back up to the 40- and 50-week averages at some point over the next few weeks. Until prices regress back to their mean, risk of whip saw will remain high and position sizes should be kept small.

Whipsaw Risk Remains High

Yesterday we wrote that the potential for a pullback in the near term uptrend was high. Indeed, the market began a pullback, while volume levels decreased. Decreasing volume during the pullback favors the argument that the near term trend remains up.

Scans today revealed little to work with. Tech stocks look extremely weak here, but they remain oversold on their weekly levels and risk of whipsaw if you force a short in this sector is high.

Banking stocks may offer us a quick long trade if they continue to pull back in an orderly fashion (meaning that volume continues to rescind with the price).

The only change to the Risk Assessment Meter today was that sentiment moved from overly bullish back to neutral. This to favors the argument that we are experiencing merely a pullback in the near term uptrend.

If we can get a deep sell off today, we may be able to buy into the fear. Otherwise, prices may need at least another day or two to consolidate and pull back before it is safe to buy.

Explanation:

Long term, the market is in a confirmed downtrend. However, the near term trend is now up. Following the failure of Wednesday's sell signal the probabilities are now high that the price will return to the 40- and 50-week moving averages, giving the near term trend a price target of $143-$143.50.

Near term the price is currently extended a large distance from lower weekly Bollinger Band support without a pullback. Likewise, near term sentiment readings have moved into dangerous, overly bullish territory.

Outlook:

Over the next few weeks the likelihood that prices will regress back to their, as measured by the 40- and 50-week averages is high, which means that traders should have a long side bias here. Before new long positions can be safely taken, however, prices need to pull back to work off near term over bought conditions.

Examining Sell Signal Failure: Part 1 of 3

This is an important post, which contains a lot of details, so we urge readers to take the time to review it thoroughly.

Last Wednesday, following the Fed rate cut, the market rallied and then sold off hard at resistance on heavy volume. This left a broad range of shooting star sell signals on all major indices and on a large number of stocks as well. It looked like the recent steep downtrend was set to resume.

But the sell signal failed on Thursday and shorts, including us, were trapped by a whipsaw.

Could the failure have been predicted? It's not clear. We know that we weren't the only ones reading the sell signal that day.

We wanted to get to the bottom of the failure and see if we could have predicted the failure, so we spent the entire weekend examining charts. What we discovered is that while the sell signal failure was not predictable, that clearly risk of sell signal failure was high.

We mentioned last week that we were struggling to adjust or recalibrate our strategies to the bear market that arguably started around October or November and confirmed last month. Extensive research over the weekend led to a bit of an epiphany in this area, which in turn led to the development of a simple set of criteria that can be used as a tool to quantify risk and ensure that we end up more often on the right side of the trade.

We will break today's post into several parts so that it can be digested in pieces. We have a lot of territory to cover, but we believe that readers will find the read well worth it as this has the potential to profoundly impact the success rates of each and every trade you take moving forward.

SRS Risk Assessment Meter

No one knows what the market will do tomorrow but it is clear that some days risk of failure is higher than other days. We have examined the charts and have now developed a way to quantify risk using a simple set of objective criteria. Note, it is important to keep criteria simple, otherwise interpretation of the factors may be too subjective.

We will use the SPY (S&P 500) as our benchmark.

Criteria are as follows:

1. Long term trend direction
2. Near term trend direction
3. Distance from 40- and 50-week EMA
4. Distance from weekly Bollinger Band support
5. Near term sentiment readings


From the results of these criteria we can then establish objectively A) whether we should be long or short, and B) how high risk of failure is.

From today, we plan to post the daily risk level and whether the long or the short side offers the best risk:reward.

The SRS Risk Assessment Meter will help us to determine whether it is best to be:

1. Heavy long
2. Light long
3. Stay in cash
4. Light short
5. Heavy short

Today's SRS Risk Assessment Meter Results

Explanation:

Long term, the market is in a confirmed downtrend. However, the near term trend is now up. Following the failure of Wednesday's sell signal the probabilities are now high that the price will return to the 40- and 50-week moving averages, giving the near term trend a price target of $143-$143.50.

Near term the price is currently extended a large distance from lower weekly Bollinger Band support without a pullback. Likewise, near term sentiment readings have moved into dangerous, overly bullish territory.

Outlook:

Over the next few weeks the likelihood that prices will regress back to their, as measured by the 40- and 50-week averages is high, which means that traders should have a long side bias here. Before new long positions can be safely taken, however, prices need to pull back to work off near term over bought conditions.

Two potential scenarios could unfold from here, prices may extend their run over coming days without a pullback, or prices could pull back in an orderly fashion.

If prices continue to extend, it is best to stay in cash as risk will remain extremely high. If, however, prices pull back starting early this week, we would look for a SPY pullback target of $133-$134. This would offer traders a chance to go lightly long for the run back to the 50-week average at $143.50.

Regression to the Mean

In this post we will take a look at some of our research for those interested in understanding how we developed the SRS Risk Assessment Meter.

Before we get started it is important to observe two simple observations about stocks and markets.

Observation 1: Markets sometimes trend
Observation 2: Prices tend to regress toward their mean

Above is a chart of the S&P 500 between the years 2000 and 2002 when stocks were last in a bear market. There are two important things to note about this price chart.

1. The long term trend was down, but within that downtrend many countertrend rallies took place
2. Every single countertrend rally regressed back to the 40- and or the 50-week moving averages except one.

If you pay attention, a lot can be learned from this chart.

Here are a few observations that can be made from the above S&P 500 chart:

1. Countertrend rallies are likely to return to the 40- and 50-week averages, giving them a clear price target.
2. When the price is at the 40- and 50-week average opening new short positions can be highly profitable and risk of failure is low.
3. When the price is too far below the mean (40- and 50-week) short trades become increasingly more risky to take and trailing stops on open short positions should be tightened.

Finding the Forest Amongst the Trees

Now let's take a look at the current SPY chart and see if we can't determine why last week's sell signal failed, trapping short positions.

Last week the SPY gave us a sell signal on the day of the Fed rate cut. That sell signal failed and prices rallied on Thursday and Friday last week as seen in the daily SPY chart below.

Could the sell signal failure above have been predicted? Maybe, maybe not. But if we take a look at the weekly SPY chart we can see that risk of failure was high.

Note above on the weekly SPY chart that prices had reverted a great distance from their mean as measured by the 40- and 50-week moving averages. Prices could certainly have continued to fall lower, but risk of going short was high as historically prices tend to regress back to their mean.

The failure of Wednesday's sell signal broke the near term downtrend. This signaled that a countertrend rally is now in effect. Since historically prices tend to tag their 40- and 50-week moving averages during countertrend rallies, probabilities are high that we will continue to see the market rally (with pullbacks of course) until it reaches back to its mean.

Bottom line: It's a good idea to go lightly long on pullbacks, looking to take profit and go short when the SPY reaches the $143-$143.50 area.

Market Momentum Trumps Rate Cut

The Fed is tripping all over itself to lower rates. It has now dropped rates 1.25% in just 8 days. This is a historic number. Add to this a sentiment reading that is increasingly over bearish, and you would think that the trade set up would be bullish.

You would think.

The charts tell another story though. The market's downtrend pulled back on light volume in anticipation of yesterday's rate cut in a classic bear market pullback pattern. Then, yesterday's rate cut was met with a bull trap spike that trapped eager bulls in a mid day, high volume reversal. A classic failure of the 1st thrust pullback, which projects more downside to come.

It could be that the rate cut worked and the economy will pull itself together. The market may in fact not be reacting directly to rate cuts and sentiment here at all.

We think that the most apt metaphor for the market is that of an oil tanker. Oil tankers, when full, must make slow turns that cover several nautical miles before they can reverse their course. If the captain were to attempt a sharper turn, the momentum would cause the tanker to break apart.

The market is like this. Once the momentum gets going to the downside, it takes a great deal of time to change the direction of the move. Momentum is heavy after a high volume failure like the market just experienced is going to take some time to release its energy so that prices can once again turn higher.

Don't Game The Fed

The market is currently discounting another rate cut today. There is no sense in trying to game the Fed. The market's oversold condition has slowly worked its way off and we suspect that if the market jumps on a rate cut that sellers will pounce on it the way they did Microsoft's good earnings report last week.

When the pullback turns the corner we will reload with new short positions. Meanwhile it's a good plan to just sit on our hands while others jump in and assume the risk involved in trying to trade the Fed today.

Market Drifts

On Monday the market started its holding pattern that is likely to last until the Fed releases meeting minutes tomorrow afternoon.

Prices drifted higher on low volume.

"Drifted" is the key word to pay attention to here. Shorts were not squeezed and smart money was not buying. Sellers were simply on strike for the day; as they are likely to remain today.

One thing is clear. The bottom is not in yet. A trading bottom is not even in. It's best to remain patient here. The market is likely to retest recent lows and perhaps take them out before a true tradable bounce can get started.

Shorting in front of the Fed meeting is going to be tough, so manage your open positions and then wait for the right time before shorting more. A pop higher following the Fed might be the best opportunity for shorting we will get this week.

Upside Untrustworthy

Prices rolled back lower out of a pullback in the downtrend on Friday. This is a classic downtrend rollover. However, with the Fed potentially lowering rates again this week, prices may not gain much downside momentum just yet. It's probably a good idea to be stingy with your short entries here. It's better to miss some downside momentum than it is to get too aggressive shorting this oversold market too low.

That said, we believe that lower prices are in store before a true tradable bottom will be put into place. We have yet to see a true fear-inducing shake out that would mark a good tradable bottom. We would love to see the Dow down 300 points mid day at some point over the next week or two. And, if the Dow can experience such a fear inducing event, a mid day reversal would give the all go signal to go long.

Until we get something like this scenario unraveling, this market is going to be very, very hard to trust on the upside.

A Lesson in Probabilities

We've said it many times before and we will probably say it many times more, making money in the market is all about putting the probabilities in your favor. It could also then be said that you should only trade when the probabilities are favorable.

In other words, there are some markets where probabilities are so low that it is almost guaranteed you will lose money. During these times, cash should be your number one position.

How the Probabilities Stack Up Here

Before we look at the current charts we should probably explain what a situation with favorable probabilities looks like. There are many possibilities, but for the ease of explanation, we will examine a couple of high probability trading situations:

When the market trend is up and prices have pulled back to support on lower relative volume and technical indicators indicate a general near term oversold condition; probabilities are fairly good that you will see higher prices ahead. During these times it pays to look for good long set ups.

Vice versa, when the market trend is down and prices have pulled up to resistance on decreasing relative volume and technical indicators indicate a general near term overbought condition; probabilities are fairly good that you will see lower prices ahead. During these times it pays to look for good short set ups.

A Low Probability Example

On the other hand, if the trend is up and prices are in the middle of a pull back it just doesn't pay to try and pick a bottom where the pullback might exhaust itself. Pull backs are strange animals and they have a mind of their own. No one can see the future and no one knows when and where the pullback will end and prices will once again reverse in the direction of the trend. Trying to guess is nothing more than gambling. This is the environment that chews up trading accounts.

Likewise, if the market is in a downtrend, and is pulling back, you can guess where it might run into resistance, but until it stops and reverses and until the technical indicators flip back to overbought you are going to get chewed up trying to short.

Even worse, since surprises occur in the direction of the trend, you are taking a huge risk if you decide to actually buy against the broader trend.

This is Where We Are Now

We are right in the middle of a low probability environment. The market is in a downtrend; and a strong one at that. Yet prices are pulling back up to resistance. At some point there will be a tradable bounce in the downtrend, but at this point probabilities are very low for opening new short positions as we will show in the S&P chart below, and they are even lower if you choose to step in against the trend and start buying hoping that overhead resistance breaks.

Let's Take a Look at the Charts

As you can see from the SPY (S&P 500 ETF) chart below, the 10-, 20-, and 50-day averages are all in a steep decline (blue, green, and brown lines). This is a clear downtrend.

Also note that volume was heavy on the decline, but as of yesterday volume declined significantly from the previous day. This is typical of a pullback in the primary trend.

So far, so good. We have a downtrend, all major moving averages are confirming, price is in steep decline with heavy volume to the downside and decreasing volume to the upside. All the right conditions for shorting.

However, conditions are not yet right for entering new short positions.

Why? The pullback is still in tact. We can see several layers of overhead resistance including August lows and the declining 20-day average fast approaching price. Yet, until the pullback runs its course (making a lower high by closing below the previous day's low) and the stochastics indicator turns back down over eager short traders are bound to feel some pain.

We are already seeing this. Microsoft reported better than expected earnings and the market was gapping up in after hours trading last evening. We want to emphasize THE RESPONSE TO MICROSOFT IS NOT A BUY SIGNAL (unless you are perhaps a day trader).

What we are faced with today is a market that has the potential to gap up into some areas of major resistance. We are near, it looks like, a turning point where it will pay to reload short positions. But, probabilities are not quite ideal yet. We are close, but until we get there, remember, cash is a position to.

Don't be so eager to put your money to work when all systems are not quite in alignment yet.

Good Times Ahead For Traders - Investors? Not So Much

Yesterday's surprise rate cut threw a monkey wrench into the market plunge that was expected after world markets went into a melt down this week. Now the question is, do we have a tradable low in place?

We may have, but keep in mind that bottoms are a process and not an event. A huge amount of technical damage has taken place over the past few weeks and even a .75 rate cut doesn't promise to cause a V-shaped bottom to emerge.

Banking, real estate, textiles, and retail all look to have a near term bottom in place. But, volatility is likely going to continue to be massive and finding a reasonable entry point in these sectors is going to be rough.

Asia is recovering nicely today; especially China. Europe, however, is tentative as they wait to see how the US markets open today. Apple reported after hours and was gapping down last evening.

What we want everyone to keep in mind here is that this market is a falling knife. A dead cat bounce is sure to emerge from somewhere near the current price level; especially now that the Fed has offered a huge surprise rate cut and rumors have it that another .50 cut is still on its way. But a falling knife is a falling knife. It looks like the knife may have stuck in the ground yesterday, but it certainly hasn’t stopped quivering yet.

The Big Picture

It's important to take a step back and check out the big picture in order to understand where we are now at and where we may be headed next. We don't know about everyone else, but we have had a very difficult time trading this market recently. Trading is all about weighing the probabilities and probabilities are typically measured against past norms. This market has been anything but normal over the past 3 months, as we will demonstrate below. The fact that this is not a normal market environment forces traders to recalibrate their analysis to the much more violent conditions the market now finds itself under.

On to the Charts

Let's be clear. As of the past few weeks, the market is now in a confirmed downtrend with a confirmed top in place. Bounces will occur that allow for long side trades – and some of these bounces will be good ones – but the long term trend is now down and investors need to keep this in mind and consider protecting their long term portfolios.

We want to compare this current market top to the top that took place in 2000.

As you can see, above, the 2000 S&P 500 top took place over the course of an entire year. Then, when prices started to roll over they did so in an orderly fashion, simply bleeding lower.

The 2000 market top allowed institutional money time to unload their positions and get short. Retail simply held and hoped as the market dripped lower, wearing them out.

The Current Top

The current market top looks different to us. Over the past 6 months the S&P carved out a head and shoulders pattern. This indicated that distribution was taking place. But, what is different here is the way the market broke down. Rather than bleeding lower offering shorts plenty of time to add to their positions and keeping retailers holding and hoping, the market plunged.

This indicates to us that stocks have become like a hot potato here. Institutions seem to be bailing along with retail. At some point – probably some point near here – the market is going to bounce and likely bounce well. But, keep in mind that this bounce is going to be a selling opportunity. This market top began violently and it is likely to end just as violently as it began. The end looks to be a long ways off to us.

Good for Traders, Bad for Investors

This is bad news for investors but good news for traders. It will take some recalibration to get back in tune with the music of the market here, but this type of volatility leaves open wide areas of inefficiency for traders to exploit. Investors should, on the other hand, consider themselves warned.

Step Out of the Way; Things Could Get Ugly

While the US markets were closed for a holiday Monday, world markets crashed. Not sold off. Crashed. Germany was down 7% yesterday and opened down almost 5% more today. London was down more than 5% yesterday and opened 2% lower today. Japan is down almost 6% and it closed at daily lows threatening to move even lower tomorrow. China closed down almost 9% and it also closed near daily lows after being down a whopping 13.7% in just two days. India's Sensex opened down more than 11% today spurring a one hour halt.

This takes us to the US markets. There is no doubt about it. The open will be ugly. The big question is, is this a buying opportunity, a signal to cover short positions, or is it still not too late to sell?

We believe that September 11, 2001 can give us a clue. The market will surely do its own thing today but as you can see from the post 911 market crash it paid to sell at the open:

Prices on the S&P index fell 10% lower from the post 911 market open. And that also followed an emergency interest rate cut from the Fed – no doubt we will get an emergency rate cut this week.

Again, 911 is not a road map as to what will happen today. World markets seem to be selling off harder this round than they did after 911. Probabilities are pretty high that we will see a capitulation event sometime this week and next week at the latest. Probabilities are also pretty high that the gap at today's open will fill sometime in the next couple of weeks.

There are a huge amount of unknowns though. Our advice is, if you are short, stay short. If you are holding long trades, sell at the open today and reenter only after the market stabilizes; you will likely be able to enter at lower prices. Mainly, just stay out of the way today. It could be a bloodbath.

Panic Here Would Bring Opportunity

The advance decliners in all three major exchanges were pushing near 80% decline yesterday. This is typically the number we like to look for that marks capitulation. Volume was heavy, but not heavy enough to be considered capitulation. The VIX finally broke its divergence with the market price action and spiked up near levels where the last two market declines reversed. The NASDAQ is honing in on major support; an area where the market has seen the greatest amount of reversal trading over the past 1 1/2 years.

What all this adds up to is the fact that the market is much closer to a tradable bounce than it is to more pain. Conceivably we could get a wash out capitulation day near current levels that would offer an excellent long side entry.

If prices instead just bounce weakly today, we will likely still be trying to find a bottom next week.

Bottom line here is this: A panic today would be a great buying opportunity. A minor bounce today without more panicked selling would indicate that we should still keep our shorts open and that more selling is likely to ensue next week.

We are crossing our fingers looking for a panic as that's where the best trade opportunity will be.

2007 Lows Call Out

Bulls fired back yesterday causing short squeezes in some of the weakest of sectors. This fired off a rally in stocks like KLAC, trapping short positions.

The day truly didn't represent any real buying strength, however, for once the shorts covered, no follow through ensued and prices faded strongly into the close.

If the market does get a bounce here, it is likely to get hit hard with more selling. Support at current levels is thin at best and 2007 lows beckon.

Continuation Pattern Emerges

Index prices broke down on heavy volume from diamond continuation patterns yesterday. This indicates that a fresh wave of selling will follow.

The bottom in this market is a long way off still, though we are sure to get a tradable bounce at some point. The Volatility Index (VIX), which is used to measure fear, barely ticked forward yesterday so there is a lot of room for the market to move lower before true market-reversing panic sets in.

It appears that investors are waiting for a Fed bounce before releasing their shares. We suspect that they may end up releasing them in a panic a few days from now instead.

Japanese markets, which have been great indicators for projecting the US markets lately, were crushed once again in today's trading.

Stay Defensive

Prices remain extremely oversold, but even so, they continued to slip on Friday.

Buyers stepped in at the close, but buying was tentative and did nothing to erase the damage caused by severe selling throughout the day. The market has a good chance of just bleeding lower from here before a true oversold rally can form.

This is no time to be bottom fishing hoping to catch the oversold rally. It's also not the time to be getting aggressively short. It's ok to manage current short positions, hoping for lower prices as it were, but don't press by putting your entire portfolio to work here. Wait for prices to rally back into resistance before reloading. Probabilities will be much higher after the market blows off some steam.

Use Caution Going Forward

The market responded somewhat favorably to Bernanke's speech yesterday. We would urge extreme caution here though if you are thinking of going long.

Yes, the market is technically way oversold. And now the Fed promises to do something if necessary – not really anything new going on here.

If you are tempted to make a long side bet, keep in mind that you are making a bet against the primary trend. That doesn't mean that long positions won't work here, but since surprises tend to occur in the direction of the trend, risk is very high here. It might be a good idea to use call options if you are going long so as to limit the downside to the premium paid.

Japanese markets today continue to diverge lower, following through to a fresh multi month low, so this is one more headwind bulls must face in order to eke out a gain.

The long and short of it (pun intended) is that the market may certainly be at a tradable bottom here. Yet, it faces a high degree of headwinds to the upside and the path of least resistance is down from here. So, if you are long, be very quick to admit you were wrong and exit if things don't go your way.

Follow Through Significantly Higher Not a Sure Thing

Yesterday the market bounced off oversold conditions. This bounce was inevitable either sooner or later. What is not clear here is how far the bounce can go from here. Sellers are going to be chomping at the bit to short any rally here and just about every analyst out there is looking for at least two or three up days following yesterday's reversal.

The market tends to make monkeys out of the most people most of the time. Will it make a monkey out of the analysts who are looking for a tradable rally from this level? It remains to be seen.

Right now the market is pinched between the hard place of oversold conditions, increasingly bearish sentiment, and a vicious downtrend that promise to create a strong headwind for the bounces.

Barchart.com still has the SPY rated at an 80% sell in the short run and a 96% sell in the long run.

The Nikkei average, which tumbled 4% last Friday, leading to a similar sell off in the US markets that same day, bounced 2% yesterday, only to give back more than half those gains today. Likewise, London's FTSE, which seemed to be stabilizing yesterday, is struggling to keep its gains at the time of this writing today.

Without follow through on the world markets, there is certainly no guarantee the US markets will see follow through today.

This market is guilty until proven innocent and yesterday's strong reversal isn't good enough evidence to declare the market not guilty. It's a start, but that's all it is, just a start.

Market Get's It's Head Lopped Off

This is an ominous looking chart:



Above is the weekly SPY chart. A head and shoulders pattern has clearly emerged over recent months and this week we have seen the neckline of this pattern lopped off like Louis XVI's head.

Selling has been extreme in recent days, but extreme is a relative term. When the market turned the corner in 2000 the QQQQs fell 30% before a decent tradable oversold bounce occurred. The Qs have fallen 10% from their December highs so far.

We aren't suggesting a 30% drop here is inevitable, we are merely saying that just because we are oversold here doesn't mean we have to bounce. VIX levels indicate that fear isn't anywhere near extreme. This divergence between the VIX fear measure and price action indicates that prices are now firmly sliding down a slope of hope.

As much pain as this causes investors, frankly, we embrace this sell off. The market has been in distribution mode for a couple of years now and has been increasingly difficult to trade. This sell off relieves the pressure that has been building and opens up vast reserves of inefficiencies to exploit for profits.

They say that stocks take the stairs up and the elevator down. We are already enjoying quicker profits this week than we have in two months

View Any Bounce With Skepticism

Yesterday buyers stepped in at the end of the day as oversold conditions reached extreme levels. It is likely that the market will experience some type of bounce from current levels.

Right now, however, the market is guilty until proven innocent. This is not the time to step in and buy the lows for anything more than a day trade. It is in these types of markets that eager buyers provide fodder for the short sellers as stocks are passed from one weak hand to another like a hot potato.

We will be viewing any bounce here suspiciously. Keep an eye out for a run back up to resistance that occurs on decreasing volume. Volume and price is key here. We will be buyers again when a higher low is followed up with a higher high. We strongly urge readers to take the same skeptical attitude here.

Energy Reverses It's Fortunes

We have a very important rule we follow when trading breakout stocks. We never buy a breakout that occurs on one day of heavy volume. We need to see a pattern of heavy volume accumulation that indicates institutional interest before we touch a breakout stock. Following this rule helps avoid failed breakouts.

On Friday we traded two breakout stocks, FWLT and EOG. Both stocks broke out from a strong base of volume.

Yet, they failed. Not only failed, they failed miserably.

So, why did our volume rule fail to protect us this round? These breakouts failed because the market rules changed on Friday. 70% of the market has been arguably in bear market territory for several months now. On Friday, the jobs report was used as an excuse to take the remaining market leaders to the woodshed for a spanking.

The rule of the day was sell everything, and sell they did. This resulted in moving the QQQQ into a primary downtrend and led to a mass failure in the energy sector trend that had been running hard on strong oil prices.

It was a tough day followed by a couple of tough months. The failure in the energy trend, however, gives us a high probability shorting set up. Failed breakouts tend to lead to steep declines and some of the high flying energy stocks have a good ways to fall before they run into support once again.

The market spoke loud and clear Friday.

There is Always a Bull Market Somewhere

Bear market stocks, such as banks, financials, home builders, and retail broke lower yesterday even as major indices held support. This is not a good sign for the overall health of the market. It indicates that the market is under severe distribution and that selling activity is being masked by somewhat stable index prices.

The S&P and Dow have both experienced a series of lower highs and lower lows indicating that they are in the first stages of a bear market. Even so, yesterday prices in these indices refused to break lower, so we are likely to see some sort of a rally before they actually break down.

Likewise, the QQQQ held support.

Our read on this situation is that while the intermediate term outlook suggests lower prices ahead, shorter term, late comer shorts may get squeezed as those with the prescience to sell last week take profits.

Market indices are heavily testing support levels and it seems likely that the last line in the sand will soon give way. That's not likely to happen until stocks regroup a bit. In other words, focus on shorting any rallies here, but don't chase prices lower here as you are likely to get burned. And, most importantly, don't try and buy any downtrodden stocks. These stocks are likely to frustrate buyers as they wear them down by constantly bleeding lower.

Meanwhile, we have a full blown bull market in the oils and oil prices are getting ready to challenge the $100 per barrel level. A strong underlying bid is occurring in stocks like XOM and CVX.

Jim Cramer is famous for saying "there is always a bull market somewhere." We aren't sure this is entirely accurate, but it is certainly accurate now.

BTW, the Japanese market is down a whopping 4% today! This following several 2% down days. Ugly business this.

Go With The Strong Downtrends For Big Profits

It's not a good idea to try and figure out where this market is going to go next. Selling was profuse yesterday and the uptrend in the NASDAQ is now at risk of breaking down into a primary downtrend.

That said, every single time this sector has threatened over the past few years, it has fooled shorts and rallied. Will this time be any different? Only the mythical crystal ball knows.

Forget about trying to figure it out.

Meanwhile, run with what is working. After yesterday's session, downtrends in a broad number of declining sectors resumed offering shorting opportunities for the agile.

Once again, forget about working on the stocks in the middle and focus on the extremes. 52-week lows should be your mantra here.

Leave Predictions to the Gamblers Today

Monday the money managers were on vacation, leaving the day to the day traders. Prices took a dip at the close as day traders punched the clock making an exit. Essentially, we have had no valid clues over the past few sessions what to expect when money managers return today.

Going to the charts; we scanned each individual industry group looking for any areas of the market that are showing unusual strength or unusual weakness. The energies and agricultural continue to trade near their highs, which is bullish, but even these areas did not show any unusual levels of buying interest over the past few sessions.

Likewise, mortgage insurance and other areas that are in strong downtrends, like the home builders and areas of banking that are exposed to sub prime, continue to trade near their lows, but did not show any unusual levels of selling over the past few days.

For months now we have been arguing that the extremes offered some level of tradable advantage, but that everything in the middle offers only random probabilities at this time.

This hasn't changed.

And, since we haven't a clue how money managers are going to handle the extremes as we kick off the new year, it's best to pull up a chair and stay sidelined one more day.

If we had a gun to our head and were forced to make a prediction, we would guess that the weak action in December will give way to buying interest in early January. After that, it's anybody's best guess.

To be honest, it doesn't matter what the market does this year. Those who will make money will approach it objectively, they will run with the probabilities, use good money management, and if they are wrong, they will use their stops and reassess the probabilities once again. Adopting a grand theory about where the market is going to go and then betting in that direction hasn't paid off in the past and it won't this year either.

Happy New Year!

Happy New Year everyone!

Trading should be extremely light today as the session is sandwiched in between a weekend and a holiday. There is little insensitive to show up today, so most will not.

We suggest that subscribers also take the day off, rest up and go out this evening and have a great time ringing in 2008.

Don't Be A Fool

As we approach the end of the year it seems like as good of time as any to review some basic truths about stock trading.

One basic truth is that no one, no matter how smart or experienced, knows what will happen in the future. The best that can be achieved by anyone is a proper understanding of probabilities and proper action based on current probabilities.

Jesse Livermore once noted:

There arc times when one should speculate, and just as surely there are times when one should not speculate. There is a very true adage: "You can beat a horse race, but you can't beat the races." So it is with market operations. There are times when money can be made investing and speculating in stocks, but money cannot consistently be made trading every day or every week during the year. Only the foolhardy will try it. It just is not in the cards and cannot be done.

This is concisely put. In certain market environments probabilities offer better than random tradable advantages and money can be extracted from the market consistently and quite profitably by those who can read the advantages and who use proper risk management tactics.

In other market environments, however, there simply are no tradable advantages and probabilities promise nothing more than random price action. In random trading environments losses are almost guaranteed to occur because trade set ups tend to fail in choppy, random markets.

The current market environment is trendless. In a trendless environment trade set ups will just not behave the same way they will in a trending environment.

It would seem intuitive to look for ranging stocks and play the range in this type of environment, but the problem is, past performance is just not a predictor of future probability in a trendless market, so even ranges tend to be unreliable.

The solution to this problem is discipline. Heed the warning that traders like Livermore offer: " money cannot consistently be made trading every day or every week during the year. Only the foolhardy will try it." Stay sidelined when there are no advantages.

A trend will eventually emerge again and when it does, you will be able to take advantage of it only if you didn't drain your trading account trying to be in the market each and every day.

Focus on Highly Select Areas

Trading is dull and everyone knows, or at least should know that you don't short a dull market. Opportunities on the long side can be found if you focus on the right sectors and a handful of stocks that are catching a bid.

The Rest of the Week Can Go Either Way

Volume on Monday was understandably low given that it was a short session prior to the holiday. Look for volume levels to remain light until next week when the money managers return from their extended holiday.

Meanwhile, bullish sentiment has been spiking to dangerous levels even as prices have been climbing on decreasing volume. This is a warning sign that a near term correction may be coming to clear out the stops.

That said, so far the bulls remain in control of the larger trend. Let's take a look at the QID, which is an ETF that trades counter to the NASDAQ 100-based QQQQ.

Sometimes it helps to turn a chart upside down to better see who is in control of the trend. Looking at the QID is the same as turning the QQQQ upside down.

As you can see, the bulls are clearly in control as sellers of the QID have been active at resistance:



Probabilities then are that the market is slated to go higher in the intermediate term.

The near term (next couple of days) is more questionable, however. With sentiment figures turning overly bullish, we would expect to see overly aggressive longs pay a painful price for their lack of patience. In the weekly chart above the QID can turn either way here. A retest of the falling trend (rising QQQQ trend) is at least as much of a possibility as a break out to the downside (QQQQ breakout).

The message here, stay patient here and only buy pullbacks; don't be a price chaser.

Longer term: When we move into the new year the end of the year mark ups could potentially lead to a broader degree of selling. This market has been horrible for long term investors and the outlook does not promise to get better in the near term. Be highly skeptical of any upside breakouts here, they may in fact just be bull traps.

Strong Rally, But Skepticism Warranted

This rally may be just a late year holiday run. However, looking at the weekly QQQQ chart it looks like this rally could have legs. The real test will be whether it can take out December highs.

It seems likely at this point that it will. Volume may be an issue. It already decreased on Friday. This coming week volume is sure to be low as it always is during the last week of December. This will make it difficult to draw any conclusions about this market.

The last two years the market has rallied into early January and then turned back hard as selling kicked in. This year may be setting up the same scenario, so it is important to be skeptical of any move and to use trailing stops on open positions.

Buy Signal Kicks Off Santa Rally

In yesterday's report we showed how the QQQQ was at a pivotal point of support. It had to either break down or break higher. Whichever way it went, would likely decide the coming trend.

Yesterday it broke firmly higher on strong volume. This offers us a reliable and strong buy signal.

November and most of this month were teaser months. They put the market into a bearish mood and took shares from weak handed players. We don't know if the market can make a strong sustainable move out of this area of consolidation, but so far it looks like the bulls are regaining their leadership.

Changes Are Coming

The market typically moves from periods of inactivity to periods of strong activity. Over the past seven weeks, the market has seen one sharp three day drop followed by a weak, choppy, trendless environment, as can be seen in the QQQQ below.



Unless you were aggressively positioned for a short by bucking the trend and guessing the top in early November, you haven't had a sustainable trend to exploit since October.

Those with crystal balls called every turn in the chart above, but the rest of us have either just stuck to the day trade trends or have seen their positions fail to gain traction as strong moves reverse from day to day.

But the good news here is, as stated above, markets move from periods of inactivity, to periods of strong activity.

The QQQQ is at a pivotal point here. It has trend support at its current level. If it can rally from here and move up to take out December highs, we could get a sustainable trend going again.

If, on the other hand, it breaks down here, we could potentially see a bearish trend develop into the new year. Either way, this period of inactivity is drawing to a close and everyone should look for trading conditions to once again provide a trend that is exploitable.

Sloppy, Sloppy, Sloppy

The indices look to be turning the corner here, but don't be fooled. This masks the fact that the majority of the charts out there are just plain sloppy.

Don't forget that this is options expiration week. We doubt very much that stocks are going to turn around and march back up the slippery slope they have been sliding down. Sellers are likely to play games with any moves higher, so be careful, don't chase prices, keep order sizes small, and look for the one or two obscure stocks that might be bucking the non existent trend.

Turn Coming

Yesterday's selling concluded with a 70-80% down day for all three major exchanges. Sentiment figures spiked to overly bearish levels and twice as many dollars found their way into puts than calls. These types of figures are typical before a market turn.

Add to this the fact that we are near one of the most bullish seasons of the year and it makes sense to start putting together a list of potential short squeeze candidates.

Cash Remains King of the Hill

Running through scans over the weekend we get the impression that there is potential for another panic situation setting up. Sellers are getting pretty desperate in the retail and banking sectors, among others. Very aggressive shorts might work here. If we were in a true bear market it might make sense to get aggressive on the short side here. The problem is, we are not in a true confirmed bear market. In fact, seasonality would indicate that selling is close to exhausted and that we are more likely setting up for a strong reversal to the upside.

We noted last Friday that short positions taken here have great potential for trapping hapless latecomers, squeezing them as this random market suddenly reverses higher again.

This week options expire right in front of the holiday weekend. Games are going to get played. And since the largest number of positions are building up on the short side by those who have aggressively chased prices, it is most likely the short side that is going to feel the greatest amount of pain at some point this week.

We are itchy to put our cash to work, but conditions for doing so today are at least as bad as they were on Friday; and probably worse.

This market will give us something good over the next few days and as we sit in cash on the sidelines, it is our bet that the market is going to give us a really tremendous buying opportunity.

We know it's hard to be patient, but take another day and let others assume the phenomenal levels of risk that continue to build. When the risk takers pay a price for their impatience, then we will be able to step back in and reap the rewards for staying disciplined in a very tough market.

Cash Is A Good Idea Over The Weekend

Market conditions are tough; as tough as we have seen. The battle for the trend continues and trading is extremely choppy and arbitrary.

Stocks appear to be under distribution, but getting aggressively short is not an option yet. Shorts who push their luck are likely to get pinned against the wall in a Santa Rally, which remains a possibility; perhaps a probability.

Meanwhile, long positions are very vulnerable and failure rates on the long side of the trade are at least as likely to fail as they were last month.

So, what to do?

There are some good reliable downtrends that can be shorted. However, it is important to short strength and not weakness. This is a market that makes price chasers pay the price of stopped out trades.

We need to wait until prices come back to us. Yesterday we attempted a couple of shorts, but the prices moved down and not up into our entry areas. It remains highly likely that prices, even if they turn lower today, will be coming back up to areas where short positions can be put on.

Yesterday we closed out the last of our trades. In this market it is healthy to sit out the weekend in cash. Next week is a new ball game and if we wait, we will get the right set ups at the right times.

Primary Bear Market?

Talk about extreme volatility…

What to make of this market? Traders are getting jerked around like rag dolls here. Over the past month we have struggled to gain any kind of traction. In the past when we have struggled like this, hindsight has shown that we were in a downtrending market during the struggle.

Recognizing the trend when the market is in its initial stages of a downswing is one of the most difficult endeavors in the art of market analysis. We admit, we struggle in this area.

What others are saying:

Don Worden wrote in his report today: ” The market demonstrated overwhelming zeal in delivering its message. No hem-hawing around needed! The practical and safe assumption is that we are in a primary bear market."

The Kirk Report: "Be defensive, hold lots of cash, don't be complacent with your longs, protect your assets, and if you're so inclined, look for strength to short."

Alpha Trends: *summarized* There is a huge battle for control of the trend taking place on the S&P 500. $149 on the SPY is the battle ground.

How the fundamentals come into play:

We are not sure we are in a primary bear market as Worden suggests. Brian at Alpha Trends seems to have pinpointed the situation best when he shows that there is a strong battle taking place for control of the trend. Neither side has taken control yet and the reason why is due to the fact that the market is faced with a new fundamental situation.

The 1/4 point rate cut disappointed the market. There is no doubt about that. The market has determined that the credit crisis will not be eased by such a narrow cut in rates and it has projected that it expects a recession. The Fed, however, has offered up a new approach to the situation. Instead of further rate cuts, the Fed is offering to inject liquidity into the market through other means; means that are as yet untested.

The extreme volatility we are seeing may in fact be a jostling from long to short as Kirk suggests. Or, it could be that the market is trying to factor in the unknowns surrounding Fed liquidity injections.

The bottom line:

As of Tuesday's reaction to the Fed, long side trends are in question. We have continued to see some strength in the strongest sectors, such as Ag Chem, but this strength is not very trustworthy at this point.

Meanwhile, the downtrends in home building, transportation, banking, and retail are showing signs of resumption.

This has been one of the hardest markets to trade in recent memory and holiday factors and the battle for control of the trend that is taking place at this moment don't make things any easier.

It's probably best to be sitting with a good amount of cash on the sideline here and put some money to work on the short side in the downtrending sectors on days of strength.

Dip = Buying Opportunity

Over the past week prices have been climbing without pullback. This has been frustrating as a lot of good stocks have been going up without giving an opportunity to enter. It has been important to exercise discipline and refuse to chase the low volume rise.

Now that the market has sold off hard, predictably, after bullish exuberance and silly expectations for another 1/2 point rate cut, the market is giving bulls a second chance to enter the best stocks.

Today is probably a little early to step in and guess where the bottom of the pullback is going to be. Aggressive traders might try, but prudence would suggest standing to the side and looking for some sort of confirmation that support has solidified.

Bearish bias has returned, however, and a Santa rally into the end of the year is sure to cause the bears pain once again. So keep your powder dry here as this dip is the opportunity we have been waiting for.

Fed Fireworks

The Fed meets today and will release their monthly volatility wave on the market at 2:15 p.m. Look for prices to drift on low volume right up until the release. At release time, the usual fireworks will begin as huge bets are made in reaction to what the minutes mean or don't mean.

The focus today will be on language that indicates further rate cuts, or not. Speculation is sure to be rampant and the first move will likely be faded.

This is all just very normal Fed day stuff. Use the dips to buy the strongest stocks, for once the dust settles, the trend should resume.

History Repeats

July and August of this year the market corrected hard back to the long term uptrend that has been in tact over the past 5 or more years. Following the bounce off the uptrend, in September the market had created an inverted head and shoulders pattern on all major indices. Likewise, many stocks that looked set for further declines in August, had by September and October followed the broader market and created their own inverted head and shoulders patterns as well.

The reason? The Fed had stepped in to bail out the banks.

In November bears started to show their teeth once again as the banks pulled the S&P down and took the NASDAQ trend off its rails. This led to a steep decline back to the long term uptrend again.

Now, here we are again. The Fed is stepping back in and the set up is virtually the same. While major indices don't have a head and shoulders pattern to play off here, we are seeing the same sectors that ran hard in October set up with exactly the same patterns now that we are in early December.

History does indeed repeat herself and sector strength is repeating itself here. If you pay attention, you can profit from the repeat.

Big Cap Tech, Chem, and Industrial Metals are all catching a serious bid here.

The run up last week came on decreasing volume, so we should get a dip buying opportunity this week.

Pay Attention To Where Smart Money Is At

After a very tough month of November, bulls are now back in control and the strong sectors that gave us such a great profit this past fall are once again heating up for more gains.

Like this autumn's rally, it is important to be choosy about where to put your money to work. Stocks in the middle are still prone to choppy conditions; especially with the low volume nature that has thus far exemplified this rally.

Making money in the market is counterintuitive to natural logic. Stocks like MOS are overbought, yet this is where the bid is catching all the dips and where funds are putting their money in order to bolster their bottom line as the quarter runs to a close on December 31.

We can take advantage of this situation by paying attention to where institutional money is likely to support these stocks and entering with them in the high flyers. Every market environment has a theme. The theme of this market is to buy high and sell higher in the areas that the institutions are paying the most attention to.

Market Misdirect Sets Up Powerful Buy Signal

The market threw us a curve ball this week as technicals pointed to a breakdown. It can be very frustrating when the market throws a misdirection at you, but it is important to not let that take you out of the game. These types of reversals tend to turn into strong trends in the new direction.

We are already seeing signs of a strong trend developing again. The same old culprits that we profited from so heavily in September and October are once again breaking out to new highs and showing a great deal of momentum building. These include agricultural chemicals and metals and mining.

So yes, yesterday's stop outs were painful. Nevertheless, they free us up to play the true market direction, which revealed itself yesterday. Now we can once again put our money to work in the sectors that have been offering the greatest profits all year. We suspect that this week's losses will be regained quickly.

Don't Get Chopped Up Here

If you don't have anything nice to say, don't say anything at all. This has always been good advice to follow. Likewise, if you don't have anything meaningful to say, ...

The best we can offer today is that market conditions are extremely choppy. There are no good trends to follow and a catalyst to move the market may not occur until next week. It's best to stay patient here and wait for better set ups. Market predictability is an oxymoron in this environment. It is here that trading accounts get chopped up, so it's best to stand aside.

Downtrends Resume

Yesterday we noted that the longer term trend in the Nasdaq sector was still up and that shorting the broader market was not a good idea. Nevertheless, buying the broader market is not a good idea here either.

Meanwhile, we are seeing downtrends in the weakest sectors showing strong signs of exhaustion after last week's bounce. Technical conditions are ripe for a continuation of the downtrends in retail, banking, transportation, and housing.

Weakness Coming, Then Strength

Traders start off the week with few advantages. The market is quite likely to see weakness early this week. Nevertheless, the intermediate bias of the market should now be up due to the fact that the Fed is likely to lower rates yet again.

If you are a daytrader you should probably be putting on short positions over the next few days. If your timeframe is anything longer, then it's probably best to stand aside and wait for the long side to set up again before acting.

Here's why:

Using the QQQQ as our basis, note that the price is near term overbought and that the open gap below is quite vulnerable.



Swing traders might aggressively short today and hold for the gap fill, but the probabilities on the trade are less than strong. Trading rules 101 dictate that you don't trade against the trend. Below we will show how it is quite clear that shorting the market here is trading against the stronger, longer term trend.

Take a look at the QID, the ETF that trades inversely to the QQQQ (when the QQQQ goes down, the QID goes up).



It is clear that the QID is in a long term downtrend, which by default means that the QQQQ is in a long term uptrend.

So, once again, if you wish to be ultra aggressive here, open some shorts here. We believe, however, that any short positions are vulnerable to wide intraday price swings and that the smart money will be waiting to buy the next dip for a rally that is likely to last into the end of the year.