Sometimes the right offensive play is a good defense -- defend what you've got and don't let the other side gain on you. Today saw a rotation out of some of the riskier stocks into the safety of the blue chips.

Market Stats

While the DOW got a big lift today from MSFT (up +4.2%), there were only 3 DOW stocks that finished in the red today. The riskier stocks in the tech and small-cap indexes finished in the red while the blue chips finished nicely in the green. Money rotated out of the higher-beta stocks, especially the stocks that have been seeing strong momentum to the upside, and into the relative safety of the blue chips. The utility sector was also the leading sector to the upside while biotech was the weakest. These are signs that fund managers want to reduce their risk while staying invested.

The RUT has been showing relative weakness since last week and the consolidation pattern for NDX looks like a distribution pattern (rallies are being sold), which adds to the look of a defensive market. Many pundits are beating the table about the buying opportunity here, citing the statistic that the market will likely rally into the end of the year now that we've made it through September-October. But the price action, especially between the indexes, doesn't support their view. The retail investor has bought (literally) into the idea of a higher market and the NYSE margin debt exceeding previous highs proves it.

Tops in the stock market are typically a painful process for both sides and it's the back and forth choppy price action that can whipsaw traders. We're certainly seeing plenty of that lately. Yesterday gapped down and sold off before turning sharply back up. Today gapped up and rallied before turning sharply back down. This is currently looking more like a market where the HFTs are playing with each other, using an initial market move and reversal to create higher liquidity for their trading programs. It's certainly a time for caution by both longer-term traders as well as day traders.

We received some more data on the bullish vs. bearish sentiment from AAII and their Asset Allocation Survey -- equity allocations in October reached a 6-year high (the highest level since September 2007, just before the October 2007 market high). Those who want in on the stock market rally have bought in. Cash allocations are at their lowest level in five months and margin debt is at all-time highs. So we've got fund managers all in and using leverage to buy more. That doesn't leave a lot of wiggle room if the market starts back down.

The Bull/Bear Ratio climbed strongly higher last week to 3.19. This was up from 1.96 just two weeks prior and that's a rapid expansion of the number of bulls vs. bears. It means a lot of bears have capitulated and the percentage of bears fell to 16.5%, which is the lowest number since May 2011. That was when the market peaked and then went on to lose more than 21% into the October 2011 low. When the ratio climbs above 3 (3 bulls for every bear) it's often been the conclusion of the bull market, which makes sense since everyone who believes the rally will continue have already bought in, leaving a dearth of buyers to push it higher. After all, it's just one big Ponzi scheme. Caveat emptor.

But for now the bulls are tenaciously holding the market up and simply the lack of selling keeps the bulls in charge. I've been using the DOW for a while now to show the bullish potential for the market and that hasn't changed. In fact the DOW's pattern is looking more and more like the correct one, even if it doesn't continue higher, so I'll start off with its charts tonight.

As mentioned previously, we have the statistic that says a market that's up at least +10% through October will typically continue to rally into year-end and tack on another +6%. For the DOW, another 6% above October's closing price gives us an upside target near 16500. On the weekly chart I've been showing two price projections that point to 16700 so clearly the 16500-16700 area is a good target zone if the bulls keep up the pressure and the bears stay in hibernation. The top of the DOW's up-channel from October 2011 crosses 16700 at the end of December. But there's also reason for caution right here.

The weekly chart below shows the upside targets that I'm watching, the first of which has now been reached. For the 5-wave move up from June 2012 the 5th wave is 62% of the 1st wave at 15725, which was reached today. This is considered the normal minimum for the 5th wave so it could lead to a reversal of the rally from June 2012 at any time. Only slightly higher is the trend line along the highs from May, currently at 15771. The next level of resistance is the trend line along the highs from 2000-2007, near 16130. And then above that is the top of the up-channel from October 2011, near 16500 by the end of November, and finally the 16700 projections. There are a few road blocks to a further rally but the bulls haven't shown much worry about any road blocks so far.

Dow Industrials, INDU, Weekly chart

The trend line along the highs from August-September, near 15771 on Thursday, might not be that important but the top of an up-channel from June might be. The May and July highs are at the top of the channel and it's currently near 15810 so a rally much above that level would be more bullish and would likely point to at least the next resistance level near 16130 (the trend line along the highs from 2000-2007). The bearish divergence at the current high vs. the September high is another reason for caution by the bulls, especially since we have a wave count that can be considered complete at any time.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 15,820
- bearish below 15,520

The DOW's 60-min chart below shows the leg up from October 9th, which counts as the 5th wave in the move up from June 2012 (to complete the a-b-c move up from October 2011). It's a bit of an awkward count but it fits. The 5th of the 5th wave is the move up from Tuesday morning and it too needs to be a 5-wave move, which it now is (although I could argue for another small pullback/consolidation followed by one more minor new high into Friday). The bottom of its up-channel from October 15th has been holding as resistance since breaking on October 31st. The repeated back tests, which the DOW loves to do, point to an ending rally, not something stronger. It's now getting pinched between the uptrend line from October 9th through the November 1st low, the bottom of its up-channel and the trend line along the highs from August-September. The uptrend line was broken with Tuesday's gap down and recovered with today's gap up. Another break would be meaningful and at 15717 Thursday morning the bulls are going to need to hold it.

Dow Industrials, INDU, 60-min chart

Money flowed into the blue chips today and out of the riskier techs and small caps. It's much easier to sell out of a highly liquid blue chip than a smaller thinly traded small cap. SPX benefitted from the rotation today as well but not as much as the DOW. This morning's high near 1774 was about a point shy of testing its October 30th high and is showing bearish divergence, which is another warning sign for the bulls since it could be forming a double top.

The October 30 high and today's high are only a few points shy of the 1778 price projection for two equal legs up from 2009, as shown on its weekly chart below. That price projection crosses the top of the up-channel from October 2011 this week. There's higher potential to the price projection at 1829 where the c-wave in the move up from October 2011 would be 162% of the a-wave, which is the depiction in green on the weekly chart below (the equivalent projection for the DOW is the one at 16700). I'm showing the 1829 projection being achieved by the end of the year but it would be in jeopardy if SPX breaks its uptrend line from November 2012 again, currently near 1693.

S&P 500, SPX, Weekly chart

On the SPX daily chart below I show a little more upside potential for Thursday, perhaps back up to the top of its up-channel from 2009, near 1781. That would also have it achieving its 1778 price projection. One other thought is that we could see price simply spend the rest of the week consolidating sideways before heading up again next week (opex). A break below 1750 should worry the bulls but stay bullish above that level.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- stay bullish above 1750
- bearish below 1730

The choppy sideways consolidation has continued for NDX in an even tighter pattern than we see for the DOW and SPX. Other than Tuesday's small white candle we've seen mostly little red candles as rally attempts have been sold. The consolidation looks like a bullish continuation pattern but this is the same way previous major highs have been formed and it took bulls by surprise when it suddenly broke down instead of rallying. Only time will tell if the same thing will happen again but the little red candles have it looking more like a distribution pattern than accumulation that I would have expected to see if it was consolidating for another run higher.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- bullish above 3410
- bearish below 3300

I've been following a rounding topping pattern for NDX as it's been consolidating and I've adjusted it slightly to accommodate the lengthening consolidation. Between the downtrend line from October 30th and the rounding top we're close to seeing a break of resistance and that could lead to another leg up to confirm the bullish continuation pattern. The top of the up-channel from June and the trend line along the highs from December 2012 - May 2013 intersect near 3420 at the end of the week so that would be a level of interest if reached. But a break below the shelf of support near 3367, for more than just a quick break, would likely be followed by strong selling (from a failed bullish pattern).

Nasdaq-100, NDX, 60-min chart

After the RUT reached the top of its rising wedge (trend line along the highs from September 2012 - July 2013) it has been a weaker index than the others. While the short-term pattern for the pullback remains unclear (as to whether or not it confirms a top is in place), the daily chart is looking good for a top in place. Obviously that would change if it rallies above its October 30 high at 1123 but today's close below its 20-dma, which has been providing support since the November 1st test, suggests we're going to see this index head lower. Money is rotating out of the higher-beta stocks and it will be worth watching to see if the current bifurcation between indexes continues (supporting the idea that the bearish non-confirmation points to a major high forming for the market).

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 1135
- bearish below 1087

TNX (10-year yield) is close to giving us a bullish breakout signal if it can rally from here. Tuesday's rally had it breaking its downtrend line from September as well as climbing back above its neckline, both now 2.628%. Today it pulled back to test the lines as support, which sets it up for a continuation of its rally. But a breakdown would give us a failed breakout attempt and point lower. It's currently trapped between its 20-dma at 2.593 and its 50-dma at 2.692 so a break of either of those would also likely tell us which direction it's heading next.

10-year Yield, TNX, Daily chart

The TRAN has given us a sell signal after its head-fake break on Monday above the top of its up-channel from June. The failure to hold above the top of the channel, which was tested at today's high, is what gives us the sell signal. The wave count can be considered complete and a break below its October 31st low near 6929 would confirm the top is in.

Transportation Index, TRAN, Daily chart

Following the dollar's breakout from its bullish descending wedge pattern I thought it was ready for a pullback and perhaps a back test of its broken downtrend line from July. It's been consolidating since Sunday night's high and it could still pull back some more but at the moment the consolidation looks bullish for more upside.

U.S. Dollar contract, DX, Daily chart

As the dollar has consolidated so too have the metals and other commodities. Gold is consolidating around its 20-dma, currently at 1318.40, and below its 50-dma at 1332. Assuming it will break down further once the dollar starts rallying again, we should see gold test its uptrend line from June 28th and it could stay inside a sideways triangle pattern for a little longer but as long as it stays below its October 28th high it remains bearish.

Gold continuous contract, GC, Daily chart

Oil got a nice little bounce today (up +1.24, +1.3%) off its late-June low but better support should be at its uptrend line from June 2012 - April 2013, now near 91.60. That would be a nice setup for a bigger bounce before continuing lower.

Oil continuous contract, CL, Daily chart

Economic reports begin to pick up a little speed for the rest of the week and while we'll get a little employment data on Thursday it will be Friday when we hear how well nonfarm payrolls have done. There will be all kinds of explanations for the poor number (+85K expected), especially with the government shutdown so there might not be much of a reaction to the number. As always, the market will be trying to figure out if the numbers will continue to be bad enough to keep the Fed fully engaged in their QE program.

Economic reports and Summary

Prior to today the techs were getting a lift presumably from some of the excitement surrounding the TWTR IPO tomorrow, which is expected to do very well. Bullish sentiment is showing up in the IPO market as well and I can't help but wonder how the market would react if the IPO did not go well. Even if it does go well, it wouldn't be the first time a market high was made on the day of a highly-anticipated IPO.

The market has remained bullish if for no other reason than the sellers haven't shown up yet. Or at least the selling is being masked by smart liquidation efforts by the big funds. But a pattern that looks like distribution, especially in the techs as they consolidate, and a rotation out of the small caps into the blue chips gives me the feeling we're seeing a topping pattern. But it's a tricky spot -- there's clearly some additional upside potential and the momentum, even if it's waning, is to the upside. Therefore it makes sense that the bears have stayed in hibernation.

If the market is topping, or at least with fund managers getting a little defensive, we're probably just one catalyst away from some stronger selling. Bullish sentiment is very high and traders are using a large amount of debt to buy their positions. It wouldn't take much selling to start the margin calls, which of course results in more selling. That's the potential danger when we have high margin debt levels with high equity-to-cash ratios -- the selling can become much more intense than it might have otherwise been. Selling simply begets more selling and the market doesn't have any more buyers to prop things back up. People will wonder why the market is selling off so hard on no news, or even on good news.

There are plenty of reasons to believe the stock market is overpriced and overbought, which makes it hard to buy into it. But the trend is your friend and even if you don't want to chase it higher here we know it's a risky time to short it. Wait for some confirmation of a breakdown and then look to short the bounces. It's getting whippy out there so stay protected and trade carefully.

Good luck and I'll be back with you next Wednesday.

Keene H. Little, CMT

In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying