Right now the market is talking to us. We hope you are listening because we are. One look at the indexes show a lot of talking going on right now in the form of our indicators flashing "In the Zone" or at the least be aware. This is how the market talks to us.
First up the 20 day one-minute time frequency chart that covers the whole run off the recent lows.
These nano short term one minute charts all show the same thing:
A. Retest of the highs commonly referred to as resistance (red lines)
B. At trend channel resistance (pink lines)
Moving on to a larger time frame and frequency we see numerous things that make us super cautious on the longside.
In each of the above charts we see the same thing brewing in all of them.
A. RSI in overbought territory (red circles at the top of each chart)
B. Full Stochastics in over bought territory (red circles at the bottom of each chart)
C. All at trend channel resistance levels (Pink channels in OTC Comp. and Dow)
D. All are at key Fibonacci retracement levels
E. Lackluster volume on the way up in each index (not shown, but it’s there or not there shall we say)
F. In an ABC down with A is done, we are in B up (right into options expiration mind you) with a potential C down yet to rear its head.
G. Potential retests of recent highs that if they pull away from here it’s a double top at the least resistance right here.
In Summary Big Picture:
It’s options expiration. This means we could sit here for the rest of the week and chew around more. But we see too many indicators telling us that we are in a high risk zone on the longside. Those that have been here for awhile know what this all means all too well. If that’s the case then what is that saying about our Inverse ETF’s out there? Just the opposite of course.
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Technical analysis dates back hundreds of years. According to historical records, a great Japanese rice trader named Homma Munehisa (1724-1803) developed a form of TA known as candlestick charting.[1] A candlestick chart is a style of bar-chart used primarily to describe price movements of securities, derivatives, and currencies over time. It combines aspects of a line-chart and a bar-chart, in that each bar represents the range of price movement over a given time interval. It is most often used in TA of equity and currency price patterns.
Technical analysis is an art. With focus and diligence, TA can often be learned within a short period. A chartist using TA reads and interprets chart patterns and then attempts to predict the most likely short-term outcome based on his methods. Figure 1 shows a 6 month Diamonds (DIA) candlestick chart and many patterns and studies that traders often use to enhance their trading. Moving averages convergence divergence (MACD) and relative strength index (RSI) are two studies very commonly used by technical analysts. MACD is a trend-following momentum indicator that shows the relationship between two moving averages of prices, while RSI is a technical momentum indicator that compares the magnitude of recent gains to recent losses in trying to decide overbought and oversold conditions of an asset. Because candlestick charting is the basis of this handbook, I use these types of charts almost exclusively in my examples.
In the U.S., TA first gained a following from Charles Dow’s Dow Theory in the late 19th century. The six basic tenets of Dow Theory, as summarized by Hamilton, Rhea, and Schaefer, are as follows:
Tenant 1. The market has three movements (Figure 2):
The primary trend, or major trend, may last from less than a year to several years. It is bullish or bearish.
A secondary trend moves in the opposite direction of the primary trend, or as a correction to the primary trend. For example, an upward primary trend will be composed of secondary downward trends. This is the movement from a consecutively lower high to a consecutively higher high. In a primary downward trend the secondary trend will be an upward move, or a rally. This is the movement from a consecutively higher low to a consecutively lower low.…
In our article on Feb. 9 entitled "The Market Is Following A Script You Can Profit From" we decided to do is a more detailed follow up to that article with a few more examples from the past in order to cement it in your brain.
In the event the opportunity rears its head you’ll be prepared in advance and won’t be one of those people who is a deer in the headlights or the ostrich who sees the lion coming and sticks it’s head in the sand thinking that is going to help, you’ll have the tools to be able to seize the moment and take action.
Is this just a correction? Or the start of something more.
If this is just a normal intermediate term correction then it’s not over till we come down touch the 200 day averages or prior support levels in the indexes (Wave 1, The A Wave, First Thrust Down) then bounce and build all new basing structures. The building of all new basing structures are what we call bottom of cups being built and those take time.
However if this is the start of something more? Then we come down, hit the 200 day averages or prior support levels (Wave 1, The A Wave, First Thrust Down) then we look for a ABC snapback rally off of those lows (Wave 2, The B wave, Snapback Rally). That could last for a month to three months. If this is the start of something more then that snapback rally abc will fail and then watch out. Upon a failure that would be the start of Wave 3, Bombs Away, The C Wave, Katie bar the door, The wonder to behold call it what you will.
If the market really did top and this is the start of the big picture wave 3, The big picture C wave call it what you will. Then let’s look at what that looks like from a chart perspective of a former new issue leader from 2007 as an example.
This issue starts off as being in a nice uptrend and above the green line, then it proceeds to put in an early warning change in trend alert pattern called a double top. After that double top it then sells off (blue box) Everything in the blue box is what we…
Recapping the week that just ended, in a few easy bullets (with the requisite spin) and charts, from Goldman Sachs.
Performance
S&P 500 fell -1.9% this week. The Financials sector was the worst performing sector, falling - 3.5%. Consumer Discretionary was the best performing sector, falling just 80 bps. We expect S&P 500 to rise to 1300 by mid-year (+22.3%), before ending 2010 at 1250 (+17.6%).
S&P 500 earnings
Our top-down EPS forecast of $76 and $90 for 2010 and 2011 reflect +33% and +20% growth, respectively. Our pre-provision and write-down EPS forecasts are $81 for 2010 and $91 for 2011. Bottom-up consensus forecasts a 39% increase in 2010 to $79, and a 20% increase in 2011 to $95.
Valuation
Top-down, the S&P 500 trades at an NTM P/E of 14.0X (13.1X on pre-provision EPS). Bottom-up, it trades at NTM P/E of 13.6X and LTM P/B of 2.2X.
Sector views and performance
Our recommended sector weightings have generated -26 bp of alpha YTD. We have lost the most ground in our overweight Info Tech position (-12 bp). We have generated the most positive alpha in our underweight positions in Telecom Services and Utilities (+5 bp).
Second day of gains which were worth more to large caps than tech or small caps. For the S&P there was a close above the 1,100 as the S&P picked up relative strength against the Russell 2000 (large caps outperforming small caps). This may have left a substantial bear trap which could force a third day of big gains. However, even with two days of gains, stochastics of the S&P only just edged out of oversold conditions to give a ‘buy’.
The Russell 2000 outlined some of the difficulties the indices face in the days ahead as intraday strength stalled out at the 50-day MA. On the plus side there was a CCI ‘buy’ signal.
Techs struggled even though it registered an accumulation day
For Wednesday keep an eye on large caps as the best chance for a short covering rally is in these indices (S&P and Dow) but it may be short-lived (morning?) if other indices don’t participate.
This morning the market soared higher after the Gross Domestic Product (GDP) report by the U.S. government. Reportedly the GDP increased 5.7 percent in the final quarter of the year. This news was much better than economists had expected, and a rally was underway to start the day. This was another day when the good news just kept pouring in and the media headlines looked great. Then one might ask, why did the market reverse after making a 10:30 am high? Please realize that the NASDAQ was trading at 2202.00 during the morning peak and is now below 2175.00, and negative on the day.
Often when a "buy the rumor, sell the news" type event takes place it is usually because price is already built into the market. However, today many leading technology stocks have rolled over intra day even as they are at major daily chart support levels. Leading stocks such as Apple Computer (NASDAQ:AAPL) have reversed to the negative side by selling off more than eight points intra day from today’s early session highs to the recent intra day low. Sandisk Corp (NASDAQ:SNDK) is another leading stock that is getting punished today by traders and investors. However, this stock gapped lower and has continued to sell off into its daily 50 moving average at 25.80 which should be some short term support. Microsoft Corp (NASDAQ:MSFT) is another stock that supposedly had very good earnings and was trading higher to start the day. This stock gapped up higher at the open by trading at 29.90. Since that opening print the stock has sold off and reversed to the negative side.
What is this telling us when good stocks can’t hold their gains after good news? Often it tells us that conditions have changed. The market has obviously priced in the good expectations from earnings and even the economic data. It is prudent to remember that the market is similar to a pendulum. Often the markets swing to one side too far, and then to the other side too far, and rarely finds that common middle ground or equilibrium point.
With that being sad one should always realize that you can’t fight the tape and the market is always right. Therefore, price action is king and thinking or trying to impose one’s will always get in the way.
This week’s technical outlook comes courtesy of Decision Point:
While the S&P 500 had managed to squeeze slightly above the ascending wedge that has contained the index for several months, this week it dropped back below the support and it is currently challenging the bottom of the wedge. The wedge has not resolved decisively in either direction, and it is possible that there will be no clear resolution. By that I mean the wedge is so narrow that the price index could continue to drift higher, lower, or sideways to where it will have exited the wedge without a clear resolution. If so, we will ignore the wedge and look for something else to provide some clarity.
I am still of the opinion that we will see some kind of downside correction because of the abundance of negative divergences to be found on our indicator charts. The first is the gradually contracting volume seen on the chart below.
The next chart shows the three indicators of our OBV (On-Balance Volume) suite with divergences clearly marked.
Finally, we have the new highs and new lows chart. Again, you can see the negative divergence over the contraction of new highs; however, this chart gives us reason to believe that the internal problems may not be too serious. Note that there have been virtually no new lows for many months, and, without an expansion of new lows, all the negative divergences we are seeing probably have no long-term significance. For example, note that the contraction of new highs at the end of 2007 was accompanied by a considerable expansion of new lows that gave warning of much greater than normal weakness.
Bottom Line: The abundance of negative divergences keeps waving the caution flag for a correction; however, the complete lack of new lows indicates that we are only witnessing cyclical weakness during an ongoing bull market, not a major top.
The best way to sum up this week’s action is "It’s A Market Of Stocks ". We’ve seen some really nice moves in many of our featured names with some nice paydays as well.
THE MARKET IN REVIEW
As you can see we are also overbought stochastically speaking as well. This is another reason we decided today to pullback on the throttles if you will.
Zooming into the 60 minute Time frequency allows for a more magnified view. The pink line on the chart above is the same pink line on the chart below. It’s a inflection point to say the least.
A break of the pink line could take us to the lower blue line ultimately, but the first stop would be that pink line and then net nowhere for 2+ months again. Here too even in a shorter term time frequency we’ve got that overbought level flashing stochastically speaking.
Moving on to the OTC composite
In Summary:
In a recent report we said:
With the dailies showing overbought and an up up and away move we want to watch for an initial pullback in the indexes to short term new support levels. For the SPX and OTC that would be right back to their initial breakout levels as shown above. Those pullbacks ought to relieve the overbought nature of the daily charts, then we look for another move higher baring an unforeseen news driven event. It’s in that potential move higher that our current watch list ought to shine.
If we are going to top it will most likely be after we pullback then make another run attempt.
Those comments still stand.
We will add one thing though and that is the chart below.
This chart covers the OTC composite off the 2002 lows and was our most recent cyclical bull market. What we want you to notice is in almost every single year this index has run into the end of the year and then went into a correction shortly thereafter. Folks we are in that window. It can happen at any time. Personally big picture you might want to stop thinking about the next 20-30% up move and start to think more about how am I going to protect what I’ve recently recouped off the March 2009 lows. After all, the last time something of this magnitude happened it took 25.3 years to retest the highs.
It will be interesting to see how the Fed and Treasury juggle the various markets that do not play well together, being stocks, dollar, and Treasuries, and of course those nasty reminders of dollar mortality, gold and silver. Although the ADP report tomorrow may be a bit light, we think the BLS will do its duty and show us a jobs positive report on Friday.
Gold Daily
The objective for gold is obviously to break back above its 40 day moving average, and take out 1140. The bear are defending this area with a vengance, shorting every rally.
Silver Daily
If silver can take out 18.40 it’s off to the races and a new high.
US Dollar (DX) Daily
The dollar needs to take out 78.50 to label this rally as more than a dead cat bounce and keep going. If it takes out 77 and the moving average to the downside then we are looking at a key support test at 76.
US Dollar Commitments of Traders
Dollar is severely overbought by the funds and specs.
Small Caps and Tech continued their good form. Technicals continue to support the move higher for Small Caps (Russell 2000) with new highs for the MACD and +DI line. The Russell 2000 would have to give up 25 points (or 4%) just to test breakout support at 650.
The prior underperformance of the semiconductors was undone with today's 2% gain.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
(