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Monday, December 7, 2009

Lots of Shake-outs. Will They Lead to a Break-out?

Friday capped off an interesting and volatile week that was characterized by the major indices thrashing back and forth between well-defined support and resistance levels in whipsaw fashion as traders tried to navigate head-fakes in both directions. It's been a wild ride, but Friday's session may have marked an important transition point. Overall turnover increased noticeably, and the Dow Transportation Index, which is often regarded as a barometer of overall market health and direction, closed at a new 2009 high. This could turn out to be a big deal, although bulls still have a little more work to do in order to hoist the market clear of the long-term resistance that rests  just overhead and that has made the territorial battle up here so intense.

Just as noteworthy as the transports' breaking out in Friday's session were the sharp reversals in precious metals and the dollar. Gold rallied briefly to yet another new high before reversing hard on heavy trade, while the dollar spiked off a support level and closed above its 50-day SMA for the first time in months. Both moves were dramatic, but we need to see if there will be follow-through action, as one day does not a sustainable reversal make. Gold's impressive rally was very extended and overdue for a correction, and the dollar still needs to prove it means business this time around. We've seen many technically oversold bounces quickly fizzle out all the way down from March highs, although this one does appear more convincing so far. And for those of the opinion that the rally in gold is now over and done with, the chart up next should give you pause. Seasonality, a projected target from the pattern breakout, and the duration and percentage moves of rallies past all argue that further upside is likely on the way .

Next are two charts of the U.S. dollar, first a daily chart highlighting various support and resistance levels and the close above the 50-day SMA, and next a weekly chart showing the big picture for another perspective.

The $SPX, meanwhile, has continued its sideways consolidation and formed a bull flag-like pattern in the process, although it is still vulnerable until or unless it can close decisively above the pattern. Note that it has also been arguing with the primary trendline off the March low. At this point I am still marking the 1,229 area as a general target for this rally, although that doesn't preclude a possible correction or two before it gets there. It also doesn't preclude ultimately bypassing that target, but that's about as far out as I'll try to project at this stage. The leading index closed Friday's session in the middle of the day's trading range, preserving the suspense through the weekend.

In terms of recent breadth readings, advancers outpaced decliners nearly 3:1 on Friday and new highs outpaced new lows 304/8 on the NYSE and 135/26 on Nasdaq. The NYSE Summation Index appears to be turning up ever so slightly off a support level, and the ratio-adjusted Nasdaq McClellan Oscillator looks like it may be poised to head higher in the near-term.

Clearly, the market is in transition, and Friday's action gave us a few new pieces to the puzzle to play with. We're seeing unmistakable signs of some sector rotation taking place, and on most fronts it is looking increasingly as if we're setting up for a new rally leg higher. But will the market be able to rally if the dollar rally continues? The market's resilience has been impressive throughout the rally, and even the global shock waves from the Dubai default scare were quickly shrugged off as the initial plunge almost immediately reversed. Indeed, repeated shake-outs, while violent as they've occurred, were followed by a return to the high end of the trading range in short-order. Dow Theory is in the bulls' camp, the fabled Golden Cross took place some time ago, the $VIX is in the cellar, interest rates are zilch, the $RUT is rebounding nicely after an overdue correction, the transports closed at a new high on volume, and many stocks are at or near all-time highs. And all that said, it is critical that vigilant attention be paid to risk management until we see a decisive break from this trading range-- up or down. And until then, it's still premature to be placing big bets in either direction. By nearly all indications, however, we should have our answer soon.

Whether you want to call this a new bull market, an engineered bull market, or just plain bull is beside the point (or at least it should be). Both economists and closet economists tend to make notoriously poor traders, and those waiting for vindication or rational markets may be waiting indefinitely. If you're an active trader, ultimate success or failure will hinge largely on how unbiased and dispassionate you are about the market's moves and direction. It's really not about forecasting; it's about managing the plays the market gives you and learning to profit from them as they come.

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