Market Update: At The Crossroads

Many of the early earnings reports appear to be surprising. Lets see how Alcoa reports tomorrow, and how it affects the stock price. Should be interesting. Two very bullish days (confirmed by a very high up volume ratio) somewhat negate the possibility of new lows in the near term, but as we know anything can happen in the market.

Notice above the Breadth Ratio has screamed higher the past two days, very similar to what was seen in the past few dips. The question remains, how long will the buy the dip scenario last? Also take note the total volume is much lower the past 2 days, despite it mostly being all up-volume.

Anatomy of the Bear-Market Rally

I thought I would post this chart to show you what my take on this market rally has been. Perhaps this will better explain why the market is moving the way it is. In the chart above, I've marked rallies off the dips in a green box, consolidation period in gray, and the corresponding sell-offs in red. Here is a 3 step pattern that is apparent to me and probably pretty simple explanation of how the market works:

1) Green: The buy programs begin with bulls buying at the dips thinking they are getting good prices on their favorite undervalued stocks. Along the way buy stops are being triggered for all the people who went short. A break of highs triggers a short squeeze, making the entire rally typically equal to the size of the previous consolidation + selloff period (price & time). Breakout buyers then continue the rally a bit higher until the gray area....

2) Gray: This area represents a lack of buying. A battle between the bulls and bears to gain control. Shorts start entering and the people who bought the dips start selling. Some breakout buyers come up with gains, others are trapped and begin to sell.

3) Red: Eventually the sellers begin to pick up (something I've noticed because of divergence in my breadth indicator) and support levels begin to give way. Heavy amounts of shorts begin to enter the market thinking the top is in. Support is reached and the cycle then starts over with green.

One thing to note, due to the volume being heavier recently on the selloffs, there could be two possible reasons that I can think of for this. The volume was much heavier before the rally, obvious bottom-callers were getting into the market, perhaps a bit too early, but at much lower prices than today. (1) Now that they've seen pretty hefty gains they are selling out,willing to call it quits for a while after experiencing pain last year. (2) The other possibility is that the big institutions and hedge funds are beginning to position themselves for a move lower. I believe the volume will only get weaker from here on out on the upside. This makes the most sense to me.

Cycle Chart:

Here is an interesting chart I'd like to share with you. This cycle has marked within a day or two some very significant turning points in the market. This supports the idea that the 1080.15 price on the S&P is much more important then our 1039 high a few weeks ago. The next cycle points to around 12/31/2009. So IF we do go higher, and many price targets lead to 1120 at the max, then we are going to see a very choppy road ahead. The other possibility is we go even higher to the 61.8% retracement which lies around 1230. As hard as that is to believe, who knows it COULD happen, but I doubt it. One other possibility is that we are seeing a retracement rally to retest highs, perhaps a fakeout/capitulation move. We saw something very similar in this cycle in May of 2008, where the cycle marked a significant peak, but not necessarily the true high.

-MktMike