Small caps lead the way?

Last week I wrote a newsletter focusing on the key levels for the S&P and Dow that we would need to watch in order to get a sign of the next move in the overall stock market. For review, please go to http://www.themeshreport.com/2010/11/where-are-we-going/ The resistance level on the Dow seems to be around 11,200 – 250 and the corresponding resistance for the S&P is around 1200.  Although earlier this week it appeared that support might be breaking instead, the markets have rebounded nicely today.

Please look at the current position of the S&P and Dow below:

You can see the resistance levels above and also the brief break of support on the Dow. However, the S&P did hold support and both indices have now rallied back up to resistance. So, can we break higher?

Maybe small cap stocks, as measured by the Russell 2000, can give us a potential hint? Please review the chart of the Russell below:

The Russell seems to be breaking higher today. If the Russell can hold its gains, and even move higher, it could be a sign that the larger caps will follow. When investors are in the mood for risk, it is not uncommon for the Russell to reflect that mood. Small cap stocks tend to be the riskier plays, thus the potential for greater gains.

The Tale of the Tape: Seeing the Russell break higher today should be a sign that the Dow and S&P will follow, but I would urge caution until that actually happens. Remember, the Russell isn’t going anywhere without the “big boys”. If the broader market can confirm the Russell’s breakout, this should provide an excellent opportunity to enter various long positions as long as the breakout holds.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Where are we going?

The past few weeks in the market have been somewhat choppy, to say the least. I must admit that there has to be some concern that the stock market could not hold the recent break above their April high. It reminds me of the 2007 all time high in the Dow. Please look at a chart of the Dow from back in 2007:

See how we briefly broke above the July high in October, only to quickly fall right back below it. Well, we all know what happened after that!

Although I will not go as far as to say that same scenario is unfolding now, it does put recent moves into some context. Please look at a recent chart of the Dow:

Sure looks familiar doesn’t it? Regardless, since breaking back below he April high, the Dow seems to be stuck in a very tight range between the 11,200/250 resistance and the 11K support. The S&P equivalents would be 1200 resistance and 1175 support. At some point, the markets will have to break one of theses levels, either higher or lower. Keep tabs on them for some insight into the next market move.

The Tale of the Tape: After breaking back below the highs from April, the stock market seems to be congesting within a very tight range. The break one way or the other should dictate the next significant move in the market. Trading within this tight range could be very choppy and difficult. Don’t be afraid to sit it out and wait for the breakout or breakdown. When the break comes, you will be better able to decide what side of the trade you want to be on, trade accordingly and with higher probability.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Dollar up, Euro Down?

As I’ve often discussed in my Chart School newsletters, there is an inverse relationship between the dollar and the euro. In addition, as the dollar goes, the stock & commodities markets have been going in the opposite direction. So, analyzing the dollar can give you some insight into the possible direction of assets such as the euro, stocks and commodities such as gold and silver.

First, let’s review the long-term chart of the DXY dollar index.

As you can see, the DXY bounced on its long-term uptrend line (black), as we would expect. Had the DXY broken lower, I would have expected the dollar to move lower, thus the stock market, euro and commodities to move higher. However, the DXY having held that support and moved higher, it is not a surprise that the euro, stocks and gold/silver have moved somewhat lower. So, what next?

Let’s take a look at the UUP next. The UUP is an ETF that “tracks” the movement of the dollar. If you wanted to profit from a move higher in the dollar, but didn’t want to trade currencies, you could buy the UUP.  Please review the chart below of the UUP:

Taking a closer look, you can see that the UUP has broken through its down trending resistance line. It also quickly came back down and retested that old resistance as a new support. This seems to validate the importance of this level. So, having broken through resistance, one would probably expect the UUP (dollar) to move higher.

What about the euro? Take a look at the FXE, which is the ETF equivalent of the euro:

You will first notice how the FXE and UUP look like mirror opposites of one another. More importantly, the FXE is currently sitting on its up trending support line. If the dollar continues higher, wouldn’t you expect the FXE (euro) to break lower?

The Tale of the Tape: The DXY has tested its long-term support and started to move higher. The UUP has broken through a key resistance level. All signs appear to point toward a higher dollar over the short-intermediate run. A long position in the dollar/UUP could be a great play. This might also be a bad sign for gold/silver, stocks and the euro.

If you choose to trade other assets based on this information, wait for a breakdown in the market you will be trading. For example, if the FXE were to break its key support, you might want to short the euro/FXE. The same could be applied to stocks or commodities like gold and silver.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

S&P rally seems to be over…for now.

Well, we’ve had it good for a couple of months now. The markets have run up somewhere around 15%, the elections are out of the way and QE2 is no longer a mystery. As a matter of fact, it would appear that the markets expectedly rallied in anticipation of those elections and the QE2 announcement. So, a pullback was probably to be expected. The question now becomes: How far will we pullback, or will a pullback turn into something bigger?

I decided to put together a quick update on levels to pay attention to on the S&P here in the short run. Please review the chart below with my notations:

As you can see, the S&P has recently broken below its trend line of support. The next level to watch would be the 1197-1200 area, as shown on the chart. If we break that level as well, I’d expect a fall to at least the 1150 area.

Also, do not forget my previous newsletters in regards to the stock market’s correlation to the dollar and commodities. If the dollar and commodities gain momentum in their most recent turns, the stock market could sell-off more than the typical pullback that is expected.

The Tale of the Tape: After a great run in the markets, a pullback appears to have started. The S&P has already broken one key level of support and seems to be preparing to break another in the 1197 area. If that level breaks, expect lower prices. Watch for stocks to pull back to lower levels of support for new entries in long positions. Possibly enter short positions depending on the extent of the selling.

Waiting for the most opportune times that I have outlined above could provide you with higher probability entry points. No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.

Good luck!

Christian Tharp, CMT

Are silver and gold done?

As most of you know from reviewing my previous Chart School newsletters, it is somewhat important to follow the commodity and/or currency markets to gauge the stock markets possible direction. Over the past several months in particular, there has been a direct link between the rising stock market, rising commodities and sinking dollar. If one of these markets were to show signs of turning, couldn’t that be helpful in recognizing the potential turns in the other markets?

For this article I would like to review commodities, specifically silver. Since silver and gold have been moving essentially lock in step, there is no need to review both. However, feel free to analyze gold and you will see similar aspects in what you will see with silver. Also, silver seems to be “leading” other metals higher. Earlier this week I noticed silver hitting an area of potential resistance.

Please review the following chart of silver with my added notations:

The first thing you should be aware of is the up trending resistance line I have drawn. Since this chart of silver only shows closing values, I extended the trend line to where silver would roughly meet that resistance. It would appear that silver would meet the trend line somewhere in the $29.50 – $30 area. So, isn’t it worth noting that silver hit an intraday high of $29.34 on Tuesday? Another question: Does the near-vertical trajectory of silver look sustainable?

An additional way to analyze silver would be to look at the silver ETF, SLV. This ETF would be a way for an investor to buy silver without actually buying the metal. But before looking at SLV, I’d like you to review Investopedia’s definition of a common candlestick pattern know as a Bearish Engulfing pattern:

The above candlestick pattern is common, and meaningful, when a security has went on a sustained rally. A similar candle pattern to a Bearish Engulfing (BE) would be a Dark Cloud Cover (DCC) candle pattern. The only difference being that the closing price of the DCC doesn’t “engulf” the previous day’s opening price. With that in mind, please review the 6-month chart of SLV below:

You will see that Tuesday’s reversal candle is at least a DCC candle, but it sure looks close enough to a BE candle as to not worry about splitting hairs. The implication is the same: A potential reversal has occurred. What adds more validity to the candle pattern is the volume on that day. The SLV had a 650% increase in normal volume on that day. If that doesn’t sound like the end of a run, I’m not sure what would be!

So, does this mean silver couldn’t make one more stab at its up trending resistance? Of course it doesn’t. Remember, technical analysis is more about probabilities rather than absolutes. The point of this analysis is to recognize that there may be reason to suspect a turn in silver, and of course gold with it. If a turndown in silver/gold were in fact happening this week, wouldn’t we also expect a downturn in the stock market?

The Tale of the Tape: Silver (and gold) appears to be showing signs of a reversal. The silver commodity has approached a long-term resistance and the SLV has formed a key reversal candle pattern on a massive increase in volume.  Taking a short position in silver could be considered, or, if the stock market does follow suit you might also look at potential short opportunities in the stock market. Considering the rallies that these markets are currently in, short positions would be aggressive, but the reward might be worth it. You would want to at least be cautious and protect any long positions.

Waiting for the most opportune times that I have outlined above could provide you with higher probability entry points. No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.

Good luck!

Christian Tharp, CMT