Keep your pants up!

As the saying goes: “Don’t get caught with your pants down!”

Last week the market broke to new highs on the Fed’s announcement of QE2. I am in the camp that the installment of another QE program isn’t necessarily good news in the long run. Regardless, the markets rallied nicely at the end of the day on Wednesday and then again on Thursday. In addition, financials finally got up “off the mat” and took part in the rally. So, does this mean the markets are embarking on a renewed up trend?  It would appear so, but it’s definitely not a forgone conclusion.

I have to admit that I was just as surprised as anyone when the markets hit new highs last week. Actually, I never even thought we’d be able to get back up to the April highs, let alone exceed them. As I began to re-evaluate this market’s latest move, this “surprise” reminded me of some other times I have been surprised by the markets hitting a new high.

Please review the following charts of the S&P 500:

The first chart is from the all time market top in 2007. I remember thinking that a bear market had probably started in July and August only to have us hit new highs in October. Hitting the new high surprised me, but it turned out to simply be a fake-out and the start of our current bear market.

The second chart is less than a year later. The 1400 area had been a very important price level for the S&P. So, breaking above it in May once again surprised me. As it turns out, this was a fake-out as well and down we went.

Now, am I saying that our recent breakout is a false one? Who knows? Interestingly enough, the markets have yet to follow through on Thursday’s breakout. If we pullback over the next week or so, which I fully expect, I will be curious to see how the volume pattern unfolds. If you look at the previous fake-outs and the selling that followed, volume accelerated on each move lower. If volume does not increase on any pullback, then I would expect that it is just a pullback. However, if we break back below our April highs and volume starts to pick up, I’d have to ask myself if something bigger has started.

Lastly, if you review my previous “Chart School” articles, you are aware of the link between commodities, the dollar and the markets. I would highly advise watching the currency and commodity markets as well as the stock market.

The Tale of the Tape: The markets have broken out to new highs. It would appear that the markets are heading higher. However, sentiment is high and the environment is ripe for a pullback, if nothing else. Watch the April highs. Watch the volume on any pullback. Look for breakdowns in gold/silver and to what extent they occur. Don’t get complacent and use your stops.

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

What to watch for on Wednesday

As everyone knows by now, today’s elections and Wednesday’s Fed announcement are probably going to be pivotal in dictating the stock market’s next big move. For the most part, the market hasn’t moved much over the last week or two. So, what will the market do after Tuesday and Wednesday?

Well, it would appear that the market has rallied higher and higher based on the expectation of Tuesday’s election results and/or Wednesday’s Fed decision. This sounds a whole lot like the “buy on the rumor, sell on the news” set-up. But, does that mean the market is definitely going to sell-off this week? Right, if I knew the answer to that question then I wouldn’t need to analyze the charts! However, my belief is that the market is setting up for, if nothing else, a pullback of some kind. Let’s remember, the stock market has rallied around 15% over the last couple of months without any real pullback of any kind. So, if the market has rallied in expectation of this week’s events, then what would propel the market higher once the events are over?

And that’s my concern for the stock market: The market already expects Republicans to take control of at least the House. The market also already expects the Fed to announce its QE2 measures for the economy. So, if those reasons are supposedly why the stock market has rallied so well lately, then why would we continue higher once what the market expects actually happens? Once again, it sure does sound like the “buy on the rumor, sell on the news” scenario I mentioned above. Unfortunately, the market is never that cut and dry. Ultimately though, couldn’t the market itself tell us what it plans to do?

Please review the following charts:

On the first chart of the Dow, you will notice the channel that the Dow appears to be traveling within. The topside resistance does seem to be important to the Dow. However, the next (2) charts of the Dow and Nasdaq probably paint a clear enough picture of where we are. Notice that where we’ve been stalling over the last several weeks on the Dow, and recently on the Nasdaq, isn’t really a surprise. Both indices have approached their respective April highs and are now sitting tight. Ultimately, if the markets break above these levels, wouldn’t you expect the next move in the markets to be higher?

Lastly, although I have not included the S&P in this analysis, keep that index in mind if the Dow and Nasdaq do in fact break higher this week. The S&P still sits 2-3% below its April highs. The Dow/Nasdaq aren’t going anywhere without the S&P.

The Tale of the Tape: The markets have rallied strongly in supposed expectation of this week’s events. They now sit under formidable resistance. This would not be the most ideal time to enter new long positions. However, if the markets manage a clean break higher on STRONG volume, I would expect another leg up in this bull market. That being said, if for example the Dow cannot hold 11,000, I would expect at least a pullback in the market. Waiting for a better entry would be in order under that scenario.

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

Rally vs. Dollar – Update

Since I last reviewed the market’s rally and the correlation to the dollar, the markets have continued to grind their way slightly higher. This bodes the question of whether or not anything has changed since my last review.

First, I’ve previously made my case that the rise and/or fall of the dollar is the key to the next major move in the market.  There has been a very obvious inverse link between the dollar and the equity markets. To review my take on this link, please go to: http://www.themeshreport.com/tuesday’s-sell-off-or-2-day-rally/ and http://www.themeshreport.com/time-to-look-at-the-dollar/

With the above articles in mind, please take another look at the dollar index, which I have included below:

Even though the markets have ground out slightly higher gains over the past couple of weeks, the dollar is holding its ground above its trend line support. Eventually, the dollar will have to do one of two things:  Either 1) Continue, and most likely accelerate, higher, or 2) Break support and continue much lower.

The reason why I say “accelerate” is because of the extreme bearishness I discussed in my previous articles. If the dollar were to gain any momentum on the upside, I would expect the equivalent of a short squeeze. However, if the dollar were to break lower, that could be the fuel needed for another leg up in the markets.

Ultimately, I believe that the Fed decision on Wednesday could be the piece of data needed to answer the question as to what the dollar’s next move will be. The obvious thought would be that the Fed’s issuance of QE2 would cause the dollar to move lower, but could it instead be a case of “buy on the rumor, sell on the news” for the markets?

The Tale of the Tape: The dollar appears to be the linchpin for the stock market’s next move. Probabilities say the dollar will hold support, in which case a long play on the dollar and/or short position on the market would make sense. However, if the dollar were to break support, shorting the dollar and/or entering new long positions in the stock market would most likely be the best trading opportunity.

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

Tuesday’s sell-off, or 2 day rally

Monday I wrote a Chart School article in regards to the need to watch the dollar index for a potential turn higher. My belief is that if the dollar were to turn higher and embark on a strong rally, the stock and commodity markets would in turn begin to decline.  This correlation is relatively well known, but some readers have emailed inquiring for more input on this correlation.

I don’t spend a lot of time trying to decipher the “whys” within the markets, but instead I let the charts themselves to do the talking. For this discussion, I will use the SPY (S&P ETF), UUP (US Dollar ETF), GLD (Gold ETF), SLV (Silver ETF), and the VIX index. First, take a look at the following charts of the SPY, GLD, and SLV:

 

Lets first recognize the correlation between the stock market (SPY) and the commodity markets (GLD and SLV).  Specifically, notice the green-circled areas on the 3 charts. Tuesday’s drops were all in sync, and on much higher volume than Wednesday’s rally. So, although the stock market regained all of its Tuesday losses between Wednesday and this morning, the rally has been on lighter volume and the commodity markets have yet to follow. Is this divergence between commodities and stocks a reason for concern?

Now, to see the inverse correlation of the above markets to the dollar, please review the chart below of the UUP:

You can see that the dollar (UUP) has been moving in the exact opposite direction as the stock and commodity markets. Once again, notice the green-circled area and you will see a jump on Tuesday rather than a rally. You will also notice the same volume increase and decrease. As with the commodity divergence, you will see that the dollar has yet to hit a new low even though the stock market has hit new highs over the last 2 days. Who’s right: The stock market, or commodities and the dollar?

Well, are traders/investors getting less fearful, or more fearful? Let’s look at the VIX, which is the volatility index:

A common definition of the VIX is “the fear gauge”.  The idea is simply that when the VIX rises, traders and investors are getting more fearful. So, although it isn’t necessarily “lock in step”, when the VIX moves higher the stock market commonly falls and vice-versa. Interestingly, as the stock markets have inched higher, so has the VIX. Are traders and investors getting more fearful of a market fall? Are the commodity and currency markets confirming this?

Bottom line, the charts above clearly demonstrate that when the dollar is rising/falling, commodity and stock markets are falling/rising and vice-versa. Even though the stock market has continued higher after Tuesday’s sell-off, commodities and the dollar have diverged along with volume.

The Tale of the Tape: The market rally, or potential topping point, hinge on the dollar’s movement. The US Dollar Index (please review Monday’s article: http://www.themeshreport.com/time-to-look-at-the-dollar/) has approached a very significant trend line of support. Unless the dollar breaks lower and the commodities catch up with the stock market, a sell-off seems to be impending.

So, enter new long positions with caution. Protect your portfolio and feel free to “dip your toe in the water” with a short position, but don’t get crazy. Watch the US Dollar Index and commodities for an “all clear” signal, which for the US Dollar Index would be a break of support.

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

Time to look at the dollar?

Back in August I wrote an article in regards the US dollar and its prospects at that time. (To review that article, please go to: http://www.themeshreport.com/and-then-there’s-the-dollar/) In that article, I analyzed the UUP as a way to review the dollar’s trend and support/resistance points.

The UUP is an ETF that allows investors to buy the dollar without actually buying the currency. In today’s market, there has been a decent correlation to the dollar’s movement and the stock market’s movement, but in the opposite direction. So, knowing what the dollar is doing can not only help you know when to trade the dollar currency if you choose, but it can also give you some insight as to what the stock market may be doing, or getting ready to do.

Below is the chart I provided of the UUP back in my August article:

At that time, it appeared that the dollar was breaking higher when we noticed the UUP breaking through its down trending resistance level (red). However, I also mentioned that there might be a concern for the dollar if the horizontal support at around $23.25 were to give way. Now, please look at an updated view of the UUP:

You can see that rather than starting a renewed uptrend, as I personally thought it was doing, the dollar instead turned lower. In September the UUP broke the key level of support at $23.25 that I referenced in that previous article. This was a sign that the UUP/dollar was probably heading lower, which they both did.  As I mentioned at that time, a break of that level would be a great opportunity to short the dollar or UUP.

Well, what’s next for the UUP/dollar? My belief is that the dollar is close to embarking on a new uptrend. Why? Please look at the following two charts:

The first chart above is a 3-year view of the UUP. What you may notice is the obvious support level at $22 on the UUP. The second chart is of the US Dollar Index itself. Notice the long-term up trending support line that I have added. Both of these charts show an immense amount of support at current levels, or close to them. Volume has also been somewhat interesting on the UUP over the last few months as well.

Also, are you a contrarian trader? If so, the Daily Sentiment Index provided by trade-futures.com shows a sentiment reading of 3% on the US dollar. This is EXTREME bearishness. If you need a reference, you might ask what the sentiment reading was back when the dollar bottomed at the end of 2009? 7%. If sentiment is an indicator you use, doesn’t it sound like now could be a time to consider going long on the dollar, especially at the current support levels? Could this also spell trouble for the stock market if a bullish dollar analysis is correct?

The Tale of the Tape: After breaking key supports in September, the dollar fell lower as one might have expected. The UUP/dollar have both reached very important support levels once again. Bearish sentiment has also reached an extreme. This could be a great time to look at entering a long position on the UUP/dollar (one could also short the euro). It might also be a good time to watch for a breakdown in the stock market.

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