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Why This Market Isn't Rocket Science

By Chris Rowe June 13, 2007 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Over the last two weeks, I talked about the fact that NYSE short interest was at all time highs.  In other words, there was a record number of shares sold short by bearish traders that would eventually have to be "covered" or bought back.

I said that if the market drops, it would have a hard time staying down for a long time because the bearish traders who had sold stock short would be inclined to take a profit, and when they repurchased their stock at a profit, the buying pressure would likely push the market higher again for the short term.

Obviously, we've seen some institutional distribution days lately (which is easy to see, based on the heavy volume on the down days and the light volume on the up days.)  The first distribution day that I highlighted in blue shows high volume which was also highlighted in blue.

For the next three trading sessions, you can see that the volume was very light as the NYSE composite moved higher.

Then you can see that the next high volume day which is the second trading activity and volume highlighted in blue, was an up day, but you can see that the level that the market closed at that day was close to the bottom of the day's trading range.  In other words, the market tried to rally, and it got smacked back down.

Let's zoom in for a second here.  I highlighted in blue (on May 10, 2007) the first major decline.  This wasn't on any major volume, so I didn't bother highlighting the volume at all.  But as you glance to the right, you can see that with each distribution day, the volume increases.  You can also see the "bearish hanging man" at the top of the trend, which is a precursor of a turnaround.  (Notice the light volume on that day, which is circled in blue.  The light volume indicates that the market wasn't necessarily pushed higher due to heavy buying, but due to limited selling.)

It's important that you're aware of the heavy distribution days that have been unfolding.  The major trend (which is up) is still intact.  The NYSE Bullish Percent still stands around 72% (which is a high level), while the short-term indicators are on sell signals.  When we can clearly see the institutions selling stock (clearly institutions because of the huge trading activity,) we have to exercise caution, and reduce our downside exposure a bit.

That's all that I have this week for you.  This isn't my most educational or informative article ever, but more of a reiteration of what I've been saying for the past few weeks:

The trend is still higher, but we are sitting in the "nose bleed seats" and we should be cautious up here.  If you reduce your exposure when the market is high, you will have money to buy on the dips.  If the market keeps running higher, then at least you didn't sell out of everything, but you still hold a large part of your long portfolio.

Tighten your stop losses, use in-the-money call options (instead of buying stock) to reduce your downside risk, and consider reducing the volatility of your portfolio by trading ETFs instead of individual stocks.  It isn't rocket science. 

Until Next Thursday, folks!