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Just a normal pullback.... so far

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"We've reached a top!" cries a bear as the Dow Industrials (INDU) 8,330 -1.42%, S&P 500 Index (SPX.X) 878 -1.3% and NASDAQ Composite (COMPX) 1,290 -0.2% show losses for a second straight session after not having posted two consecutive losses since trading lows on October 10th.

But not so fast says the point and figure technician in me. Institutions looking at the charts and investors alike understand the current action is simply a little pullback. There's a heck of a lot to be done before some type of "top" can ever be called. The first thing to look for on the point and figure charts is some type of "sell signal."

Dow Industrials Chart - $50 box

The first sign of meaningful weakness in the Dow Industrials (INDU) would come with a trade at 8,100. So far, each pullback has seen a reverse higher, followed by another point and figure buy signal. Subscribers will remember a past update where we showed the above chart, with horizontal resistance at 8,050. At that time, the Dow was well below the 8,000 mark, but we thought a break above 8,050 was trouble for bears as risk immediately had to be assessed to the bearish resistance trend at 8,350.

While bears may be implementing some trades it should be done with NO MORE than 1/4 positions!!!!! I'd expect FIRM support at the 8,050-8,000 level.

Trader's and investors can see that a trade down to those levels would indeed have the Dow's point and figure chart giving a sell signal, but an old point and figure chartist saying is, "the first sell signal in the upward trend is often times a buying opportunity."

Traders and investors can actually test this saying with stocks and indexes they trade. A test on the Dow's chart would be back at 8,100 in mid-July, just after the Dow found a relative low at 7,550. Bears that came in an shorted the Dow with full positions at 8,100 back then, got an unpleasant surprise over the next couple of weeks.

Just remember, there's some patient bulls that have yet to "chase" this market and have been looking for pullback entry points. As we get a bit of a pullback from yesterday and today, RISK for bulls is actually declining a bit.

In last night's Index Trader Wrap at OptionInvestor.com, we talked briefly about short-term bears looking to use the "inside day" trading technique. This short-term trading technique is outlined in the "Bailey's Basics" section at both OptionInvestor.com and premierinvestor.net.

Today's action has the Dow Industrials (INDU) 8,323 -1.49%, S&P 500 (SPX.X) 877 -1.4%, S&P 100 Index (OEX.X) 445 -1.73% breaking to the DOWNSIDE of this short-term pattern. Neither the NASDAQ- 100 Index (NDX.X) 961 -0.26% or NASDAQ-100 Index Tracking Stock (AMEX:QQQ) 23.91 -0.99% have yet to break below yesterday's low.

One time I mentioned that the "inside day" was somewhat similar to thinking of the bar chart as a point and figure chart. Do you kind of see how the Dow's point and figure chart and columns of O have been "inside" the X range? Only when a column of O exceeds a previous column of O to the downside do we get a sell signal. In this context, a trader looking at a bar chart may also interpret an "inside day" on the bar as similar.

The "inside day" can be traded bullish or bearish on the setup. The only thing that "determines" the direction of the trade, is the break (up or down) from the inside day. The "inside day" technique is simply a short-term play on supply/demand. Those that have a grasp of point and figure charting, certainly understand the pattern's shorter-term implications.

Jeff Bailey

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