Market Stats

The market may not have a lot of points in the past few days and the new highs this week are showing some negative divergences but the bulls haven't done anything wrong yet and rally continues to hold some additional upside potential. But I wonder if too many are expecting a rally, and buying into it, which could cause some problems for follow through to the upside.

The day was generally quiet, almost pre-holiday-like, and the numbers in the table above shows it was a mixed day. A late-day surge protected the indexes from closing marginally in the red. Even the dollar and commodities were relatively quiet. There were no major economic reports, it was quiet overseas and no big news announcements. It was a day of rest. Now the big question was whether it was a bullish rest period or consolidation before selling off again.

I've got a few more charts than usual to show tonight since I think we're at a potentially important inflection point for the market. I think the market is due a pullback but what's not clear yet is whether we should be looking for a pullback that will be a dip-buying opportunity for a run higher into the end of the year and into the new year or if instead we should be looking for a significant shorting opportunity right here right now. So rather than spend a lot of your time reading market commentary I thought I'd spend a little more time reviewing the picture that I see developing for the market.

One of the things I really appreciated about OIN when I first subscribed to the newsletter (back in 2000) was the sincere effort being made to teach traders to trade. We've all seen countless web sites and blogs that call out trades--enter here and exit there--or worse they tell you how well they did if only you had done the same trade as they did (you know, the 1126% return on XYZ option trade in only 3 days). I know the majority of you want to learn how to trade, not what to trade (although trade suggestions are always highly appreciated).

You will find some writers very bullish and some very bearish and it provides you with an opportunity to see both sides. Todd Harrison at Minyanville constantly talks about the need to see both sides. It's hard for us to fight our bias and I'm as guilty of that as anyone. So if one of us is bullish and another is bearish, simply read, study and understand the rationale for our opinions. If we can teach you how to make trading decisions for yourself you'll trade with more confidence. And equally important you'll acknowledge that it's your trade and you will not blame or credit others for how the trade goes. How many could spit nails at Jim Cramer for one of his buy or sell recommendations? Why do analysts turn most bullish with high price projections at tops, and most bearish (as in "we're facing financial Armageddon") at bottoms? It's not just retail traders suffering from that.

So whether you're bullish or bearish you need to understand where each could be right and where they might be wrong. Depending on your trading time frame you could be switching sides on a daily basis. For this reason you should understand an analyst's time frame as well. I know a lot of traders do not like to trade in bear markets or on the short side. Bear markets scare a lot of traders away (as evidenced by the drop in trading volume, especially if it were not for the program and high-frequency trading volume). While I may be bearish longer-term (next year), I hope to give both sides some trading opportunities, whether it be with the trend or counter trend. If you want to see more or less of something we're doing, please provide feedback so that we can continue to meet your requirements.

So let's jump right in and take a look at the setups as I see them currently. SPX continues to struggle with the 62% retracement of the 2007-2009 decline, at 1228.74, which it closed marginally below today. The wave pattern can be considered complete at any time now. By that I mean an A-B-C bounce off the March 2009 low may have completed and that interpretation calls for the resumption of the bear market. From a weekly chart perspective, confirmation of a high would not come until it drops below 1129. We could see a pullback to 1185-ish, staying within a small parallel up-channel, and then another rally leg into January, potentially getting up to the 1300 area.

S&P 500, SPX, Weekly chart

Zooming in on the leg up from July, I'm showing a 5-wave count, which is why I'm saying the rally could be considered complete here. Yesterday's candle was a shooting star after gapping up, making a new high and then closing lower. It created a buying climax which is often a key reversal day. There was no follow through to the downside today so there's no confirmation of the key reversal. That leaves the bulls still in charge. Only a drop below 1200 would suggest the bulls have turned the ball over to the bears. But below 1220 would be a bearish heads up.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- cautiously bullish above 1220
- bearish below 1200 and more bearish below 1129

Zooming in closer to the leg up from November 29th, which I'm counting as the 5th wave, it also counts out well as a 5-wave move and that's what's had me looking for a reversal. The 5th wave even achieved equality with the 1st wave by tagging 1233.52 yesterday. There is still the possibility for at least one more new high but today's bounce looks very corrective and as such is pointing lower. Any decline below 1220 would be a stronger sell signal but still no major trouble for the bulls until 1200 is broken. But bulls be careful here--the setup is a good one for a stronger reversal back down.

S&P 500, SPX, 60-min chart

Last week I showed the setup for a high around Friday-Monday based on the MPTS (Moon Phase Trading System) since the new moon was on Sunday. So far, assuming Tuesday's high will result in at least a pullback, it was only off by a day. And how appropriate to have a shooting star candlestick around the time of a new moon. And some say astrology is just a bunch of phooey (wink).

S&P 500, SPX, Daily chart with MPTS

It could be purely coincidental but the DOW stopped yesterday right at the trend line that is parallel to the uptrend line from March 2009 (it's attached to the July 2009 low and price seems to have found it to be resistance in the past). The price pattern is the same as SPX and therefore the bearish setup is for a strong reversal back down from here. But the bulls are not in any trouble until 11200 gives way.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- cautiously bullish above 11,450
- bearish below 11,200 and more bearish below 10,720

NDX remains oh so close to its October 2007 high but left a bearish candlestick yesterday (gapped up but sold off the rest of the day, closing at its low). The setup is the same as the others and could start a more serious decline from here. But until it drops below 2085 there remains a possibility for a choppy rise higher into the new year (depicted with the dotted line), finishing at the October 2007 high. This is just a guess but so far the corrective nature of the move up supports it. The other possibility, shown with the dashed line, is for a steeper pullback and then another rally leg into January. But I'll worry about that possibility if and when it drops below 2085.

Nasdaq-100, NDX, Daily chart

Key Levels for NDX:
- cautiously bullish above 2200
- bearish below 2085 and more bearish below 1918

The RUT is at an important level and I want to show the weekly chart to give a sense as to what it's facing and where it could go. There is a price-level support/resistance band at about 760-764 and it was a bullish move when it gapped above and held above 764 yesterday and again today. It could certainly continue higher from here and the next price-level resistance is near 800. But I think the RUT is ready for at least a pullback in which case the move above 764 would look like a head-fake break (not that this market ever does anything like that).

Russell-2000, RUT, Weekly chart

If the market does pull back this month it's not going to be clear as to what the longer-term pattern will be into the early part of next year. With the 50 and 200-week moving averages and an uptrend line from March 2009 all located near 660 by the latter part of January, that would be strong support and could launch another rally leg from there (green), which would likely be a strong rally. A break below 660 would be the first indication on the weekly chart that the bulls are in trouble.

Moving in closer to the rally leg from August, the RUT has popped above the top of a potential rising wedge pattern, currently near 762 (so right in the middle of the 760-764 price-level support/resistance zone). So far that's bullish but a drop back below 760 would leave a throw-over finish to the rising wedge, which would be a sell signal. Confirmation would not come until the RUT breaks below the bottom of the wedge near 736. From a wave pattern perspective, the bulls would not be in trouble until the RUT dropped below 720. If the bulls continue to hang on here, a move up to at least 785, if not 800, looks to be the potential.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- cautiously bullish above 764 up to 785-800
- bearish below 720 and more bearish below 672

Anyone watch Bernanke being interviewed on 60 Minutes Sunday night? I'll be kind and not call him a liar but his quivering-lip interview had me wondering how much faith he has in the American people to understand what he's really up to. I about fell off my chair when he answered the question about printing money by saying the Fed was not doing that and that they were only intending on keeping interest rates low so as to help economic growth. Even Jon Stewart caught him in the "misstatement" of facts: Jon Stewart's Bernanke Observations.

As to the Fed's efforts to keep yields low, well, let's just say it isn't working out as planned. Yet another conundrum in the bond market. You would think the Fed would learn that they don't control the bond market. The 10-year yield, which has the most influence on mortgage rates and many other variable-rate loans, has been climbing and this week it's been spiking higher. I've had 3.1% as a level I've been watching for and then I expected a pullback at a minimum. Bond players are telling the Fed to get out of their sandbox as they sell off their bonds, afraid the Fed is losing it and cause more of an inflation problem. Don't forget, it's the Fed (Bernanke) who never saw the crisis coming in the first place. And now he's going to fix it? The bond market apparently thinks he'll just make things worse.

Today Treasuries prices dropped the most since the Lehman bankruptcy. This has got to be causing more than a quiver in Bernanke's upper lip. The chart of the 10-year yield below shows the strong climb up through the 38% and then 50% retracements of the April-October decline. Not even the 200-dma at 3.1% slowed it down. The long-legged doji today has the potential to be a reversal candlestick if tomorrow we see yields turn back down. Then it will be time to watch the pattern of the decline to help determine whether it will be just a pullback (green) or the start of a more serious decline (red). A climb from here above 3.4% could indicate we're about to see yields shoot higher (4% quickly).

10-year Yield, TNX, Daily chart

Higher interest rates would put a lot more downside pressure on real estate, both homes and commercial. I continue to watch the DJ REIT index (DJR) carefully because I think it will provide a good heads up for the broader market, just as the housing industry gave us a heads up before the market topped in 2007. The rising wedge pattern for DJR's rally off the July low was convincingly broken in November after a classic throw-over finish on November 5th. I pointed out the sell signal on this index the following week, especially with the failed retest at the bottom of the wedge on November 11th.

After dropping sharply to the November 16th low it has been bouncing in a bear flag pattern and reached the 62% retracement of the November decline. Today it broke down from the flag pattern and the next leg down should be starting. Keep in mind that rising wedge patterns tend to get completely retraced in a much quicker time than it took to build it so back below the July low probably in January, possibly sooner. The first downside target is the H&S objective near 183. SRS is an inverse ETF for the real estate market.

DJ REIT index, DJR, Daily chart

A widening spread between the short-term and longer-term bonds (steepening of the yield curve) helps the banks since they can lend money (if they lend money) at a better rate than they pay on deposits. Actually I have little doubt that this is the true motive behind the Fed's QE program but clearly that's just a guess on my part. The banks have had a very strong run since the November 29th low, coinciding with the time TNX took off to the upside, and today the BIX tested its November 5th high at 141.70 (closed just shy of it at the day's high of 140.61). There is price-level resistance at 140.00-141.60 based on the quadruple highs back in June and July. So far the test of this resistance zone is leaving a bearish divergence on the daily chart so a turn back down would leave a double-top reversal. If the bulls can drive BIX above 142 on a closing basis that would be a bullish statement.

Banking index, BIX, Daily chart

Another money-related index that I like to watch is the broker index (XBD). It provides a good sense for how people and brokers are doing in the market. Currently we've got a very clean a-b-c wave pattern for the bounce off the July low. The 5th wave is just shy of the price projections at 118.79 where it would equal the 1st wave in the move up from late August. Currently it's just shy of the 78.6% retracement of the April-November decline and is very close to the trend line along the highs from July. Lots of potential resistance just overhead.

Broker index, XBD, Daily chart

Besides the money centers, another good sector to watch is basic materials since that will give us a sense about how well the economy is doing. IYM is the DJ Basic Materials ETF and it's interesting to see how it rallied back up to its broken uptrend line from March 2009 through the February 2010 low, which was broken in May. The move up from July can be counted as a completed 5-wave move to complete an A-B-C bounce off the March 2009 low. It could press a little higher this month and we don't have any sell signals on this one yet but it's now very close to signaling the possible completion of the 2009-2010 rally.

Notice the 62% projection for the c-wave at 75.99. Yesterday's high came within 14 cents of that level and has reversed sharply (pretty amazing after a run of more than $45 over 21 months and it gets within 14 cents of its projection (62% and 100% are the two most common projections for a c-wave). Slightly higher, at 76.48 (0.63 above yesterday's high), is the 78.6% retracement of the 2008-2009 decline. It's a setup for the start of the next bear market leg down but obviously price will need to prove it and there's a lot of work the bears need to do. The first bearish clue would be a drop below 71.25.

DJ Basic Materials ETF, IYM, Daily chart

On Friday the TRAN finally tagged its 5065.68 price projection (wave-c = 162% of wave-a) and its broken uptrend line from August. Yesterday it spiked back up in the morning, tagged the broken trend line again and fell back. Today it closed below 5065 and yesterday's low, confirming yesterday's shooting-star reversal candlestick. The pattern for the move up from November 16th supports the idea that we'll see the TRAN stair-step a little higher (dashed line) but the risk is for it to start heading lower from here. Confirmation of a high would not come until it drops below 4917. So far the TRAN's climb above the November high has not been confirmed by the DOW, leaving a bearish non-confirmation from a DOW Theory perspective.

Transportation Index, TRAN, Daily chart

I'm not quite sure yet what the dollar is doing. It was looking very bullish until last week's pullback which was larger than the first pullback in mid November. That calls into question the impulsive wave count to the upside and now the dollar has broken its uptrend line from November 4th and finding it to be resistance, including today. It could be setting up for a larger pullback to the 78 area before setting up another rally leg. I have little doubt the dollar will be rallying much higher; the only question is what form the rally will take. Short term, a deeper pullback in the dollar could give the stock and commodity markets another shot in the arm.

U.S. Dollar contract, DX, Daily chart

Tonight I'm going to take a look at the dollar and commodities with a longer-term perspective so we can keep a bigger picture in mind. What the dollar and commodities do over the next few months will likely have a big effect on the stock market. The dollar is either in a very bullish pattern with higher lows since the March 2008 low or it's in a sideways triangle bearish continuation pattern. In either case I see a rally up to the 87-88 area (downtrend line from March 2009) and that will put a lot of pressure on stocks and commodities. What it does from there is something we can worry about when it gets there.

U.S. Dollar contract, DX, Weekly chart

The stock and commodity markets will likely remain more in synch than not so keeping an eye on the commodity index (CRB) can help confirm a move or alert us to the possibility one or the other is in a false move. CRB has been in a parallel up-channel since its March 2009 low and has tagged the top of it while testing the November high. So far the test of the high is showing a fairly significant negative divergence, hinting at the possibility we'll get at least a pullback from here. It remains bullish as long as any pullback does not drop below 280, the August 5th high. In the meantime be careful about any further upside if you're playing in the commodity market.

Commodity index, CRB, Weekly chart

Gold is getting pinched. It's in a rising wedge pattern from October 2008 and the final move up from July is also forming a rising wedge. You can see the significant bearish divergence on RSI since the high in early October. There could be a little more upside (1480-ish) but holding out for more moves you into the hog's group (pigs get fat, hogs get slaughtered). The high in gold could be a very significant one.

Gold continuous contract, GC, Weekly chart

Silver is showing the same reversal potential. It has rallied up to the top of a parallel up-channel from 2008, in November and again yesterday. It's leaving a bearish divergence at the new high. The wave count calls this the end of the rally from October so like gold, this could be a very significant top that is forming.

Silver continuous contract, SI, Weekly chart

I want to get in a little closer on the oil chart because of the potential reversal signal we might have received this week. Yesterday price jumped briefly above the top of a rising wedge pattern but then did a sharp reversal back down and closed inside the wedge, leaving a shooting star candlestick. Price action since yesterday's low looks corrective and points to lower lows for oil. The longer-term pattern is a setup for a significant decline from here but the bulls are not in trouble until oil drops below 82.

Oil continuous contract, CL, Daily chart

There were no significant economic reports today. Mortgage applications were less bad at -0.9% vs. the -16.5% last week. This is a very volatile number so week to week it's not very helpful. The trend remains negative. Crude inventories dropped but that didn't help the price of oil much. Tomorrow will be light as well, with unemployment numbers and wholesale inventories.

Economic reports, summary and Key Trading Levels

In summary, the charts are warning me of a reversal in the making. At least that's the potential. At the same time bullish sentiment is scary high. One look at VIX, and especially VXX, you can see there's no fear out there. Everyone is convinced the Fed won't let anything bad happen (tell that to the bond holders) and that we're going to get our Santa Claus rally. I'm beginning to wonder if Santa is going to be able to get his sleigh off the ground with all the bulls that have clamored aboard.

The dip buyers are active and call buying is going through the roof, as evidenced by the ISEE call/put ratio (which does a good job at measuring newly created speculative positions vs. hedge and spread positions). A chart of the 5-dma of the ISEE equity-only readings shows a spike above highs seen in 2007 and April of this year, which is clear evidence of the bullish exuberance out there. Santa's sleigh is looking overloaded indeed. Rarely does the market accommodate so many betting the in the same direction.

ISEE Equity-only Call/Put ratio, 5-dma

When I see as many reversal setups as I currently see, combined with extreme bullish sentiment, it has me on the edge of my seat wondering what could trigger a selloff. Sometimes it's nothing more than good ol' fashioned profit taking. There are a lot of profits to protect right now and while fund managers may have been caught in chasing performance to the upside I suspect more than a few are nervously perched over their sell buttons to protect what they have. We could see a sell-first-ask-questions-later response to any piece of news, be it domestic or foreign.

But keep in mind that the reversals, or setups for reversals, are very early. This market has had a knack for immediately reversing the reversals, especially with so many looking to buy the dips. There may be enough buying power to hold the market up into the holidays and then we'll deal with a potential hangover afterwards. I think it's a market that requires caution by both sides right here.

Tomorrow is another big Fed POMO (Permanent Open Market Operations) day with the Fed scheduled to buy another $7-$9B. This will be the last one for the month. Whether it will have an impact on either Treasuries or the stock market is the big unknown. It certainly hasn't helped the bond market. As many have observed, this week's auctions have gone poorly, the weakest since February. As mentioned earlier, bond prices haven't dropped as hard as they did today since the Lehman bankruptcy. As far as the stock market benefitting from the Fed's money creation (correct that, Bernanke said Sunday night that he's not creating money), I think it's more a factor of trader hope that the Fed is helping to hold us up. The market is overdosed with hopium and the backside of that euphoria could cause some painful withdrawals.

So be careful out there--I sense a tipping point but the market hasn't done anything wrong yet. We've got some early sell signals but no confirmation to the downside. Trade both sides carefully, good luck and I'll be back with you next Wednesday.

Key Levels for SPX:
- cautiously bullish above 1220
- bearish below 1200 and more bearish below 1129

Key Levels for DOW:
- cautiously bullish above 11,450
- bearish below 11,200 and more bearish below 10,720

Key Levels for NDX:
- cautiously bullish above 2200
- bearish below 2085 and more bearish below 1918

Key Levels for RUT:
- cautiously bullish above 520
- bearish below 423

And remember, whether the market continues to rally to new highs over the next year or succumbs to greater selling pressure, our goal is to help you trade the moves. Teaching a trader to fish has always been OptionInvestor's goal and it's the reason I continue to write for the newsletter. I learn more by teaching and more importantly I learn from all of you who send in questions and observations. The market is a constant learning experience (part of the challenge and fun) and together we'll continue to learn how to trade this sometimes difficult market. I hope you'll take advantage of the great end-of-year special that Jim is offering. I think 2011 will present us with some very exciting trading opportunities in both directions.

Keene H. Little, CMT

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