It was a bullish day because the indexes closed in the green but that's about the most bullish thing that can be said after seeing the market not able to add to this morning's gap up.

Market Stats

The stock market rallied today thanks to the gap up. After the first 45 minutes of trading, when the market indexes made their highs, the rest of the day was spent either consolidating sideways (RUT) or pulling back (all others). The bullish case can be made since the consolidation following the morning high looks like a continuation pattern. But some of the underlying market breadth numbers indicate some distribution is happening (big firms to retail traders) and that's a little worrisome.

There wasn't much exciting from a news perspective and consequently the market spent most of the day waiting for something. In fact the rest of the week will be relatively quiet as far as economic reports go and we'll have to see how the market reacts to the initial earnings reports. It matters less what the earnings report is and more important how the market reacts to them, especially forward guidance.

Alcoa was credited with this morning's bullish start to the day and its stock was up +0.26 (+2.6%) to 9.36 in the pre-market but it then immediately sold off following the opening bell, hitting a low of 9.06 before 10:30. It tried a little bounce but failed to do much better than breakeven and ended the day down -0.02. I guess AA gave its 2 cents about its guidance and the market took it.

The commodity market in general did not have a good day, spending almost the entire day in the red. The commodities index (DJUBS) dropped below last Friday's low and then got a little bounce to close at the Friday low. The metals were also negative and a stock market rally without the commodities is not a good sign for stock market bulls. A little later I'll have an update on the commodities index to show my concern about the discrepancy I have about this.

Tonight I want to review some of the sentiment indicators and match them up with what prices are doing. As traders we watch prices. Price is king. It doesn't matter why the market rises or falls since that's not what makes us money. The only thing that makes us money is being on the right side of the trade and quickly getting out of the way when we find ourselves on the wrong side of the trade. This is why I spend so much time reviewing the charts -- it's a way to identify trading patterns and look for reasons from the chart why prices might move in a particular direction and how far it might move. Trend following is one of the better methods of staying on the right side.

But there are plenty of things we can evaluate to help determine if the market's trend may be about to end. The trend is your friend until the bend at the end and it's the bend where many traders give back what they made from the trend. One good trade given back in multiple small losses. It could be just me (wink). So looking for reasons why the trend might take a turn can help us avoid the whippy patterns typical at turns (if it's not a v-bottom or top).

Being a contrarian, which is much harder than it would first appear (there's a reason herd mentality works so strongly), is a way to constantly look for reasons why your market opinion is wrong. When everyone else is peering over the same side of the boat it's generally wise to work your way over to the other side in preparation for the boat to tip over. Signs of distribution in the market is an example of large firms working their way over to the other side of the boat while the retail traders take their stock and run over to peer over the side, wondering what everyone is looking at. But if you run over to the opposite side too early you'll miss out on the trend; too late and you'll give a lot of profits back to the market.

Market breadth and sentiment are two things to keep an eye on when trying to figure out if too many traders are getting too bullish or too bearish. At the moment there are many measurements that indicate the market is getting too bullish and some short-term indicators that we might be in the bend at the end. One of the first short-term indicators that caught my attention yesterday and today was the TRIN. For a reminder, the TRIN (TRaders INdex, which should be called the Arms Index from its creator Richard Arms, developed in 1967) is calculated by taking the difference between advancing and declining stocks (the a-d line) and dividing that by the difference between the volume of advancing and declining stocks. A normal (balanced) reading is 1.0 and a weaker market is indicated if it climbs above 1.00 and is bullish below 1.0.

The TRIN can reach extremes that warn us the market is getting too one-sided and typically readings below 0.50 indicate the buying is getting too frothy. It takes high readings, typically above 4.0, to indicate the selling has turned excessive. But it doesn't take extremes for this indicator to be useful. I like to use it to confirm what I'm seeing in prices and when they disagree it's time to pay attention. For example, Tuesday's rally off the morning low was met with a rising TRIN, which indicated the sellers were stronger than the buyers but "someone" was working the indexes higher (creating divergence between the broad market indexes and the underlying stock market). All day the advance-decline volume stayed negative, indicating more volume was going into selling than buying. The TRIN had worked its way back up to near 2.0 by the close, which was simply a warning.

The warning from the TRIN did not matter Wednesday morning with the gap up but TRIN spiked up to almost 5.0, dropped quickly to 1.0 and then immediately started working its way higher all day again, hitting 2.0 in the afternoon. To me this was showing us there was an underlying effort to distribute stock without affecting the indexes. The big trading houses are masters at this and we have tools to use to find them. Sure enough, shortly after the gap up and a run higher to a market high in the first 45 minutes of trading it was all downhill from there. We had plenty of warning that the gap up might not hold.

There are some other longer-term sentiment indicators worth reviewing. I consider these to be warnings and not market timing tools. When I have a chart pattern that suggests we should be looking for a reversal I like to see if the sentiment picture supports that view. At the moment we have excessive bullishness and chart patterns that suggest the rally could be running on fumes so again, this is not a timing tool but I think it warrants caution by the bulls -- it's certainly not a good time to get complacent and assume each dip from here will be a good buying opportunity. At the very least, manage new long trades a little more closely right now. I view the current market as too late to buy, too early to short.

I found two interesting charts at to highlight this point, the first one showing the small traders' position in the market vs. the commercial traders' positions, identified by their net percent open interest as of the last week of December. The chart below also shows the large speculators' trading positions, a group identified as trend followers (think Jim Cramer) that has been very bullish, and extremely so, since the fall. The small traders (the retail traders) are at a historically high net long position that's been growing since their net short position at the October 2011 low. The spike at the end of December says retail traders are "all in." On the opposite end of the scale are the commercial traders who have been legging into a larger short position since the fall and it looks like they were the sellers to the retail crowd at the end of December and have now created a historically large net short position. Guess which group is the smarter group to trade with?

SPX vs. Traders' Positions, weekly chart, courtesy

The next chart shows the results of a poll that's taken by Market Vane of stock market advisors, which is their Bullish Consensus indicator. It spiked last week up to 68%, which is now near the same level as previous market highs -- 69%-70% levels were achieved at turning points in the past two years. When it hit 70% in September 2012 it was the highest reading since the October 2007 high. With the seasonally bullish time (through the first week of January) now completed and prices pushing up into resistance, combined with the bullish sentiment identified in the charts here, it's a dangerous time to look for additional market highs (new market highs are certainly possible but don't get complacent about expecting it to happen).

SPX vs. Market Vane's Bullish Consensus, chart courtesy

The collapse in the VIX is another sign of bullishness and complacency. After punching up through the top of its Bollinger Band on December 28th (hitting an extreme of about 4 standard deviations) it has quickly collapsed back down to the bottom of its BB, currently at 13.08. It's the largest one-week move since before 1999 (as far back as I checked) and looks suspiciously like a capitulation of buyers in the stock market (and/or a flushing of shorts out of the market). With today's low at 13.22 it also dropped below last August's low at 13.30 and came close to the trend line along the lows from April 2010, currently near 12.98. This line has supported every pullback since 2010 and it could break this time but is that a good bet? It will matter when it matters but be aware the setup favors the bears here.

Volatility index, VIX, Weekly chart

The chart below shows how SPX is back testing its broken uptrend line from October 2011 while the VIX tests support, shown above and below. Does this look like a good time for you to be bullish the market? The stock market can always surprise to the upside but that's a bold bet right here.

S&P 500 vs. Volatility index, VIX, Daily chart

To start off with a different index than I normally show, the NYSE is a good broader-market index to watch. It includes some foreign ADRs and bond funds so it's arguably not as good as the Wilshire 5000 but it's still a widely watched index and many of our breadth indicators are based on the NYSE index.

The weekly view of the NYA shows it has rallied into a nest of resistance identified by trend lines, Fibs, Bollinger Band and a previous price-level S/R. The trend line across the highs from March-September 2012 is currently near 8640 and NYA popped above it last Friday but has struggled below it this week. Today's close was at 8636. An uptrend line from June 2012 was broken in November and it was back tested on December 19th and now again (it was tagged last Friday near 8674). The price-level resistance near 8630 starts from the high in May 2006 and a Fib projection for the leg up from November is near 8640. The top of its weekly Bollinger Band is currently at 8609. All of this adds to the probability (not guarantee) that the 8609-8674 area should be a tough resistance zone, which is where it's been struggling since gapping up on January 2nd. It has formed a potential island top but only if it gaps down from here (just something to be concerned about).

NYSE Composite index, NYA, Weekly chart

I've got a few price projections showing on the chart above and they're basically showing price relationships between the waves of the move up from October 2011. The first 3-wave move up into the March 2012 high had two equal legs near 8348 (the high was a little shy of that at 8328). The next leg up from June to September 2012 achieved the 62% projection of the 3-wave move up to March 2012, near 8405 (it made it a little higher than that). Now the leg up from November has achieved the 62% projection of the June-September rally, near 8641 (a little higher than that so far). These 62% relationships are typical in a rising wedge pattern, which is a bearish pattern and the wave count can be considered complete at any time. The new highs since March are showing bearish divergence so that's confirming the bearish interpretation of the rising wedge pattern. This is why the Fibs and trend lines have me watching carefully for a reversal at any time. But if the bulls can march this index higher, the next price projections that line up nicely are near 9135.

The daily chart of the NYA below shows the trend lines grouped around the 8630 area. The top of a parallel up-channel from November, which stopped the rally last week, is currently near 8750 by the end of the week so that's some upside potential for the week. But if it drops below the January 2nd and 8th lows near 8570 and into the gap it could be a quick trip down to at least close the gap and test the bottom of its up-channel.

NYSE Composite index, NYA, Daily chart

All week, since last Wednesday's gap up and strong rally into resistance at SPX 1460-1467, I've been watching for evidence of a turn in the index. So far there is no impulsive pullback from the high on Friday, January 4th and that keeps the bulls alive. I've been saying for well over a week now that it would be bullish above 1468 and that remains true. Just be careful of a head-fake break higher, a quick tag of the top of its up-channel from November, near 1478 by Friday, and then a reversal (creating a bull trap). But with upside potential to the 1503-1515 area there's clearly room for the bulls to run if they clear resistance and don't look back. At 1502.76 the climb off the November low would have two equal legs up. The trend line along the highs from April-September 2012 (arguably the top of a rising wedge pattern) will be near 1515 by opex Friday, January 18th. I don't like the pattern to the downside from Friday, from a bearish perspective, but a drop below Tuesday's low near 1451 should be viewed as potentially bearish.

S&P 500, SPX, Daily chart

Key Levels for SPX:
- bullish above 1468
- bearish below 1450

Looking at the rally from November, the 60-min chart below shows the up-channel and how the top of it was tested twice last week. It also achieved the price projection at 1462.78, which is where the 2nd leg of the rally is 62% of the 1st leg. The a-b-c move up from November can be considered complete at that point and that combined with the hit of the top of the up-channel is the reason I've been watching closely for signs of a reversal. So far the 3-wave pullback from last Friday's high does not confirm a high is in place but I've seen many tops get put in just like this one. That's why a drop below Tuesday's low near 1451 would be bearish. Whether it will lead to just a larger pullback before heading higher again or start a more serious decline will have to be figured out later.

S&P 500, SPX, 60-min chart

The DOW shows a similar pattern to NYA and SPX. Bullishly it pulled back on Tuesday to its broken downtrend line from October through the December high, near 13290, which becomes an important level for the bears to break. It has met its Fib projection at 13436, where the 2nd leg of the rally from November is 62% of the 1st leg up. It was also a little shy of back testing its broken uptrend line from October 2012, which would have been the 3rd test and potentially sets up a "3 drives to a high" reversal. There's still some upside potential if the bulls can rally the market into next week (opex) but the pieces are currently in place to call a top.

Dow Industrials, INDU, Daily chart

Key Levels for DOW:
- bullish above 11,860
- bearish below 11,530

A look at the NASDAQ Composite index, instead of NDX tonight, shows it too is battling its broken uptrend line from October 2011. It popped above it last Friday but then dropped back below it and today was only able to give is a kiss. A drop from here, especially below Tuesday's low near 3076 would be bearish. In the meantime the bulls still control the tape and there's upside potential to the top of its parallel up-channel from November, near 3167 by Friday. Further upside potential is 3202, for two equal legs up from November (note that it already achieved the 62% projection at 3106) and then the trend line along the highs from March-September 2012, near 3240 by opex Friday, January 18th.

Nasdaq Composite, COMPQ, Daily chart

Key Levels for COMPQ:
- bullish above 3118
- bearish below 3076

The RUT has been consolidating near the trend line along the highs from July 2007 and May 2011, currently near 874. As I've been showing for a couple of weeks now, there's upside potential to the 883-890 area. A Fib projection at 882.68 (for the 2nd leg of the rally from November) is only 3 points higher than today's high and the top of its parallel up-channel from November as well as its trend line along the highs from January-September 2012 (the top of a rising wedge pattern) are now near 890. A little throw-over above that level followed by a reversal back below it would create a reversal signal. A drop below 868 would likely indicate the top is in place.

Russell-2000, RUT, Daily chart

Key Levels for RUT:
- bullish above 890
- bearish below 868

The weekly pattern for the banking index (BKX) looks like it might have completed its bounce off the October 2011 low with a 5-wave move up from October 2011 inside a rising wedge pattern, which fits for the c-wave of an A-B-C bounce off the March 2009 low. The only problem with this count is that the c-wave (the move up from October 2012) is very short -- it's only 50% of the a-wave (the March 2009 - April 2010 rally). But this is entirely possible considering how weak the banks have been relative to the broader market since the April 2010 high. The 50% projection is considered the minimum expected for a c-wave and in this case reflects the significant weakness in this index. With the small throw-over above the top of the rising wedge, near 53, last Friday and now the drop back inside the wedge today it creates a reversal signal. But the pattern could morph into a higher bounce and needs a drop below the uptrend line from October 2011, near 48, to confirm the top is in place. Just be aware of the initial sell signal here and if we're to follow the money we should be thinking short if the weakness in the banks continues.

KBW Bank index, BKX, Weekly chart

The daily chart of the BKX is shown below and it zooms in on the rising wedge pattern. Last Friday's rally had BKX popping out the top of the wedge, which is the trend line along the highs from March-September 2012, and that's been followed by a close back below the line. The short-term pattern supports the idea that we could see one more new high (dashed red line), perhaps up to the 55 area by the end of next week. But a drop below 51.50 would be a strong indication that the rally as finished.

KBW Bank index, BKX, Daily chart

Following the low in November for the home builders I had made a projection that the index could see the 500 area before it completes its rally from October 2011. It was one of the indexes that kept me cautious about the short side for the broader market since it was hard to imagine a new high for the home builders without the help of the broader market. For much of December I was beginning to wonder if I was wrong about this index but since last week's rally and some more this week it's now looking like the 500 area is in play. However, the minimum upside has now been achieved and the wave count be considered complete at any time. The new high above this past October's high is showing bearish divergence, which is what I expect to see for the 5th wave of the move up from October 2011 and it will help confirm the final high if the 495-508 target zone is achieved and the index rolls over from there (or here). A drop below the December 27th low near 432 would confirm the high is in place.

DJ U.S. Home Construction index, DJUSHB, Weekly chart

As a reminder for the upside target zone for the home builders, I've got three Fibs pointing to the 500 area, which provides good correlation that it's going to be an important price level. For the A-B-C bounce off the November 2008 low the c-wave would be 162% of the a-wave near 495. For the c-wave (the 5-wave move up from October 2011) the 5th wave would equal 62% of the 1st wave near 504 and a 38% retracement of the 2005-2008 decline is near 508. The rally from October 2011 is inside a parallel up-channel and the midline of the channel is where the 5th wave often stops. That midline is currently being tested near 485 (today's high was 485.37). There's no guarantee that the index will reach 500 and of course there's no guarantee that it will stop there either. At the moment the rally could complete at any time now and a drop below the low on December 27th, near 432, would indicate the top is in place. This index will likely be a good canary to keep our eyes on.

The U.S. dollar's pattern continues to support the bullish picture. I had viewed the 3-wave pullback from November into the December low, with two equal legs down to 79.02 (the low was 79.01) as a bullish setup. I'm looking for a minor new high above last Friday's (projection is to 81.25), a pullback to the 80.00-80.30 area to correct the 5-wave move up from December 19th (assuming we'll get the minor new high first) and then a stronger rally into February (above 83) following the pullback.

U.S. Dollar contract, DX, Daily chart

As mentioned earlier in the report, commodities were negative today, despite Alcoa's positive earnings report. And this continues the negative picture we've had from commodities. I've shown previously the comparison of SPX and the commodities index and it's not a pretty picture for stock market bulls. The commodity index has significantly lagged the stock market and it's a big red flag at the moment. Either commodities wills start rallying or the stock market will decline. The divergence will not continue much longer.

The rally in the commodity index was stopped in September at its downtrend line from July 2008 through the April 2011 high. That line needs to be broken before the longer-term downtrend is broken. In the meantime it's in a shorter-term down-channel from September and currently in the middle of the channel. It's trying to find support at price-level support from previous highs and lows since the lows in December 2011. The short-term picture is potentially bullish as it completes a 5-wave move down from September, with bullish divergence against its November low, which sets up a bounce to correct the move down. But the 5-wave move down establishes the trend for now -- after a bounce correction it will head lower again. We could see a bounce back up to its downtrend line from 2008, near 145 next month.

DJ UBS Commodity index, Daily chart

Gold's pattern remains a bit choppy and could go either way but until it can rally out of its down-channel from October, the top of which is near 1710, I'll continue to look for lower prices. The bearish wave count is very bearish in that it calls for a strong decline from here, one which should quickly take it down to 1525 support. That support line is price-level support and the bottom of a potential descending wedge pattern following its September 2011 high. This could be a bullish continuation pattern (more easily seen on a weekly chart) but hopefully that will become clearer if and when gold drops down to the bottom of it.

Gold continuous contract, GC, Daily chart

Oil has been stalled at price-level resistance at 93.88 since its rally up to that level on January 2nd. Oil's 50-week MA is at 93.75, which was tested at the January 2nd high and again on Monday. So in addition to the price-level resistance at 93.88 there is the 62% retracement of the September-November decline, at 94.17, oil bulls have some tough resistance to break. There is some upside potential to at least 95.37, which is where the c-wave of an a-b-c move up from November would be 162% of the a-wave. A drop below last Friday's low at 91.52 would indicate the top is likely in place while a rally above 97 would indicate new highs above 100 are coming.

Oil continuous contract, CL, Daily chart

The rest of the week is quiet from the perspective of economic reports.

Economic reports and Summary

The market is stretched to the upside and while it looks bullish with the indexes consolidating near the highs it's been a common pattern to see this at important tops. Bulls start to lean long with the expectation the rally will continue and then get spooked out of their positions with a sudden drop. Considering the sentiment picture that I reviewed tonight I think it's risky to look for more rally. I do see the potential for at least one more minor new high and if we get some serious capitulation to the upside we could even see SPX hurtle above 1500. I'd be serious seller if that happens but right now I'm from Missouri on that one.

Short term I don't have a clear picture and am recommending the sidelines while we wait to see if resistance levels are broken (on more than an intraday basis) or if key levels to the downside are broken. In the meantime be careful about getting whipsawed. Remember that the Thursday prior to opex week is often a misdirection day so watch for that possibility. Opex weeks tend to be bullish and sometimes start with a down day on Thursday or Friday. Stay nimble and trade short term while we wait for longer-term clarity.

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