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Technical Tuesday - Look Out... Above

By Chris Rowe September 11, 2012 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Technical Analysis Question of the Week:

When you spot the pattern shown below in an uptrend, what is it called?

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Last Tuesday the theme was "wait and see -- don't force it."  This week, it's showtime. 

The S&P 500 decided to break a new high.  The U.S. dollar index decided to break its up trend and reverse lower.  Precious metals decided to continue the breakout they recently started (but were being a bit "shy" about, as I mentioned).  

So it's "risk on", as they say.

First, understand the U.S. dollar adds inverse pressure to commodity prices, since most commodities are priced in U.S. dollars.  I don't like saying the dollar has an "inverse relationship" with commodities, because that's not always the case.  

When the Fed adds more quantitative easing, it dilutes the value of the dollar.  Therefore, the U.S. dollar index tends to decline when there is an expectation of more easing.  And the decline in the U.S. dollar, in turn, adds upwards pressure to stocks and commodities. 

I'll explain further, and then I'll tell you what the technical picture says about future prices...

In a speech in Jackson Hole, Wyo. on August 31st, Ben Bernanke described our job market as a "grave concern" causing "enormous suffering and waste of human talent."  Those strong words added to the consensus among traders that he is probably just waiting until after the Presidential election to add more QE.

At that point, the U.S. dollar index (below) was sitting right on the major uptrend line (blue) as well as a key horizontal level (red).  It sat there for a week, and then BOOM!  The fireworks went off last Friday on the horrible jobs report...

That's when you see the clear break below the major uptrend line.

The employment report was terrible, and that tells traders it's more likely that the Fed will enact more QE policy. 

Jobs in August only advanced by 96,000 when the consensus expectation was for 125,000 jobs.

What's worse, this followed gains of 141,000 in July which were revised down from the original estimate of 163,000.  To make matters worse, the June payroll jobs were revised down from 64,000 to 45,000!

So in addition to the big miss for August, the net revisions for June and July were down a combined 41,000.

"Bond King" Bill Gross of Pimco summed it up when he posted on Twitter saying the jobs numbers make some move by the Fed far more likely next week. 

He's talking about this this Thursday's FOMC announcement at 12:30 p.m. ET where the Fed is widely expected to leave the fed funds target unchanged at a range of zero to 0.25 percent.  Bill Gross, along with many other traders and analysts, thinks the Fed will extend guidance beyond 2014.

After the 12:30 announcement, the Fed will release its quarterly forecast and that will be followed by the chairman's press conference (at about 2:00 p.m. ET).

So, isn't it interesting that we get a nasty jobs number and that sparks a rally in stocks?

As you can see, the stock market pushed up above a key resistance level.  It's important to understand that this happened before the recent employment report.  But also remember that we started seeing weakness in the U.S. dollar ahead of the report as well. 

When the Fed adds more QE, the implication is that interest rates will be kept low, which theoretically makes it easier for companies to borrow money and do business.  That's one reason stocks advance with more QE.  But there's another reason...

More QE adds more downward pressure to the U.S. dollar (which means more expensive commodities). 

Higher commodity prices (like oil) mean bigger profits and higher stock prices for the major oil companies.  And guess which two stocks make up 5% of the S&P 500?  Exxon Mobil and Chevron Corp.  Both stocks just broke out of an 18-month base.

Next week I'll talk about 3 very important stocks that make up a combined 10% of the S&P 500:

Exxon Mobil, Chevron Corp and Apple Inc.  I'm saving the article for next week so I don't veer off course here.  But here's the takeaway for today:

Currently, the move is "risk on" and the bull market continues in stocks and commodities.  This is happening because traders expect Bernanke to continue manipulating the U.S. dollar lower. 

But in next week's article, I'll discuss the caveat.  Apple, while it continues to advance in price, looks very weak to me.  Exxon and Chevron are also suspect.  The prices of the three stocks will push the market higher as long as they continue their move. 

But next week I'll show you their weakness and how to use the three stocks to get an early warning of the next bearish reversal in the stock market as a whole.  See you then!

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Answer (to TA question from above the article):

It is a Bearish Engulfing Pattern.  This pattern is found after a price advance.  A bearish reversal pattern, like this, can only be a bearish reversal pattern if there is an uptrend to reverse. 

An "Engulfing Pattern" is a two day (time period) price pattern.  The first time period (day, week etc.) usually has a small body ("body" being the difference between the opening and closing price -- not the intraday high or lows), followed by a day whose body completely engulfs the first day's body.

In a Bearish Engulfing Pattern, the second day is a down day.  You can see below how this worked in Microsoft on November 3, 2010.

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