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Technical Tuesday - Short the Rallies! Here's Why

By Chris Rowe May 24, 2011 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Every Tuesday (the day I write for The Tycoon Report), before the article, I will list one or two "test your knowledge" technical analysis questions and after the article I'll list the answers.  I hope you find this fun and I hope it helps you make more trading profits.  Sometimes small bites can have a huge impact.

Technical Analysis Question of the Week:

1. The Air Transport sector almost always turns down ...

   a. Before the market peaks
   b. In tandem with stock market peaks
   c. After stock market peaks

2.  Why?

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We are in an intermediate down trend within a long-term up trend.  

Let's jump RIGHT INTO the charts today!

Why should you short the rallies?  Why get bearish when the market pops up a bit?   First of all -- all the cool kids are doing it.

(Click on image to enlarge)
4-Day Intraday Chart - S&P 500

Above you can see a 4-day intraday chart of the S&P 500 with 10-minute bars.  You can see, on the far right, where the market opened higher today and then sold off. 

Perhaps we will see a rally this week -- I don't know.  But the market felt the emotional jolt of bearishness yesterday when the U.S. dollar posted a VERY strong gain, the second such gain in three days.  Therefore, they may have acted emotionally when they knocked the market down, and may second guess themselves and buy this market up to a key resistance level.  I don't know.  But if they do, then get bearish on the rally.

Here's the U.S. dollar chart. 

Look at the last few sessions (on the far right).  Sure, today we are giving a little bit back (the dollar is declining slightly after the strong rally).  But that's normal.  That has allowed the stock market to rally a bit today.   Perhaps the dollar will give back more of the recent gains allowing for more upside in the stock market.   But the up days, in the U.S. Dollar, have been too strong to convince me that the intermediate dollar rally is over.  Thus, the stock market decline is almost certainly not over either.

(Click on image to enlarge)
1-Year Daily Chart - U.S. Dollar Index

That means there is more downward pressure on the stock market to come.

Now let's zoom out to a 6-month daily chart of the S&P 500 with.  You can see that we now have an established down trend line.  Any move even close to that down trend line, or even slightly above the 10-day moving average (purple line), should be sold into with new bearish positions. 

(Click on image to enlarge)

6-Month Daily Chart S&P 500

 

A lot of traders are having a hard time envisioning a strong move below the 50-day moving average (blue squiggly line).  I think they are in denial.  Even if we get a controlled sell off, followed by a strong recovery (like the March sell off), I think we have to perform similarly to the way we did in March on the Japan Disaster, in terms of the 50-day moving average. 

Why?

Because the NYSE BPI is in a column of Os (supply is in control), just like it was in March.  I wrote about that in last week's Technical Tuesday article titled "Look Out Below"

Not only that, but we have MORE stocks on sell signals now than we did back then -- more stocks participating in the sell off!

So why is the market not falling before our very eyes? 

Well, it is.  But it's not happening in front of most peoples' very eyes, because they are focused on the EXTERNAL MARKET, which is painting a skewed picture. 

Speaking of "painting" (Wall Street Term: "painting the tape")...

Right now Goldman Sachs -- oops ... I mean, the oil sector -- is holding up the market.  Propping it up is a better term.  Look at the 9 major S&P sectors:

(Click on image to enlarge)

Courtesy of http://www.sectorspdr.com/sectortracker/

The rally was even MORE concentrated earlier today.  But you may notice that all sectors are flat or down, except for the energy sector and materials sector, because Goldman Sachs was good enough to put out a report today saying to buy commodities, notably oil. 

This looks like a way to keep external markets up while they exit.  Imagine that.  The most heavily weighted stock in the S&P 500, for example, is Exxon Mobil.

If Exxon Mobil has a strong close below $79.00, it will take this market down.  I would guess XOM comes down to the low 70s.  We take the size of the consolidation area, which is above 9 points.  Then take the breakdown point of about 79, and subtract 9 points.  Nobody knows how dramatic a sell off will be, but let's be conservative and say XOM gets to the low 70s. 

(Click on image to enlarge)

Many people will read this and immediately use tons of leverage and get bearish right here.  My thinking is that it makes more sense to take some bearish positions here, wait to see if we get rallies to short into (or buy puts into), and then get in at those better prices.  Some here, some later. 

With the mess in Europe, a lot of people will say "that's why the market should go down".  But remember the "climbing the wall of worry" theory:  If there is already a mess, that means there are lots of good news announcements that may come out saying "this is fixed" or "that is fixed".   That might be a reason for the euro to rally, the dollar to fall, and equities to rise.  But if that happens, I think it will be temporary.  

I hope this helps.  And I hope you've been making money with us by listening to Morning GPS every day. 

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Answer (to TA question from above the article):

1.  A (before stock market peaks)

2.  Because they are sensitive to interest rates and energy prices -- both of which tend to rise at the end of the business cycle.

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