Sellers Arrive

On Wednesday, the bears filled up the tank with $123 oil and took a long-awaited joyride.

After a slow start, the budding correction has finally tightened its grip. While the NASDAQ printed only its second distribution day in the past four weeks, the NYSE indexes logged their 6th. Wednesday was a bad day for the bulls, as 92 of 100 stocks on the NDX closed lower, and all 30 Dow stocks ended down.

Despite the NASDAQ's relative outperformance of late, the expanding cluster of NYSE distribution days is a threat to the current rally. Since this particular rally sprung up during terrible economic times, the risks are even greater. Season your exposure to taste: if you can't take your eyes off the screen, you may be carrying too much risk.

The chart below shows a couple of possible downside targets for the NASDAQ. Filling the gap around 2350 would be a garden-variety correction and about a 10% pullback. If the NASDAQ spends more than a few days trading below 2260, it's probably setting up for a fresh leg down and a lengthy extension of the current bear market.






Corrections often start slowly and accelerate quickly, so caution is important. However, it's worth noting that for all the headline-induced drama on Wednesday, the selling wasn't as intense as the price drop suggested.

Even though the NDX fell a hefty 2.2%, a rather unremarkable 41 of 100 stocks printed distribution days. The OEX fell 1.6% and even closed below its 50-day EMA, but only 34 of 100 stocks saw heavy selling. The IBD100 saw the lightest selling of all, slipping just 1.2% with only 31 stocks seeing distribution.

By contrast, in several sessions during the January collapse, 90+ stocks on these indexes saw heavy selling. If this correction doesn't deteriorate to these levels and take out the March lows, it can recover and continue higher. Reduce risk to your comfort level, and then follow the proceedings with a clear head. Up or down, you'll reap greater rewards following the market than by trying to anticipate it.

As a parting shot, Thursday's edition of Investor's Business Daily offers a few tips for riding out a correction, and they're worth mentioning here:

-- Raise cash. It's the simplest way to reduce risk and ride out the storm.

-- Sell your losers. If a stock is down 7% from your buy point, it's an automatic sell. A stock down less than 7% can be asking for trouble too.

-- Sell stocks with small gains. If a stock has just a small gain, it can turn into a big loss quickly.

-- Consider holding onto your leaders. The best stocks often weather turbulent conditions in tact, and then recover first.

-- Avoid new buys. The odds are against you until the market sorts itself out.

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I'm traveling until next Tuesday, and will try and check in over the long weekend. Until then, good luck trading.

best

dk

The Herd

Since the entire herd was expecting this pullback, it should come as no surprise that the downside move has been so stingy.

As The Worst-Is-Over Rally gives way to the Told-You-So Correction, it's noteworthy that NASDAQ volume has declined for two sessions. Considering that the market was actually mixed on Monday and the NASDAQ has eased just 1.6%, it's clear that institutional investors are reluctant to unravel their nine-week buying spree. Throw in economic gangrene and oil approaching something like $1 million/barrel, and the bulls look remarkably tough.

After three days of selling, little technical damage has been inflicted on the NASDAQ, while the various secondary indicators have all had a chance to cool off a bit. After a weak start to 2008, the NASDAQ is now the market's leader. It's logged just 3 distribution days in the past 8 weeks, while tacking on over 300 points. As energy stole headlines on Tuesday and NYSE bellwethers sank, AAPL, RIMM, GOOG and BIDU all quietly closed higher.






On the other hand, the Dow is absorbing some heat, and has seen 6 distribution days in the past 5 weeks. Two bear raids in 11 days left a nasty double top, and it looks like the Dow has more work to do before it's ready to move above resistance. The $OEX is printing a similar formation.





It's hard to make the stock market stay down without heavy selling, and there's been little of that so far. On Tuesday, just 19 stocks on the NDX printed distribution days. Even more boggling, a mere 5 stocks(!) saw heavy selling on the IBD100.

Tomorrow offers another day for the sellers to step in, but the current action is telegraphing a market in profit-taking mode. Given there's every imaginable flavor of weak economic news at the bear's disposal, it will be interesting to watch investors sort this one out.

Until then, have a great evening.

best

dk

Time for a Pullback?

There's almost uniform agreement among technicians this weekend that, even though the market has grown more bullish, stocks are due for a correction.

Many investors looked to OEX this past week for the selling to pick up. However, the week after options expiration is actually far more famous for market tumbles. As a result, it's possible that the sellers finally show up this week, with downside acceleration into the long weekend. However, the market has made so many technical improvements over the past nine weeks that remorseful non-participants could be eager to buy any weakness.

Long-term indicators still say we're in a bear market, and broad economic conditions range from mediocre to awful. However, nothing is more bullish than a market that keeps going up. Most investors have been surprised by the tenacity of the current, nine-week rally, and a wide array of indicators show an ever-strengthening market pulse.

One of the more popular Bull Market/Bear Market Indicators involves the 65-week EMA. It's a reliable long-term indicator, and there's even a public chart list at Stockcharts called Above the Green Line which is based on the 65-week EMA.

The chart below shows that the SPX has now climbed back above its 65-week EMA, after spending the past six months below. Also, RSI is back above 50. However, it's worth noting that Above the Green Line isn't impressed, and views this as the last chance to sell before the market turns really bad.







The reason for the skepticism is evident in the chart below. The 13/34 weekly EMA is one of the most commonly followed long-term bull/bear indicators. Until the blue line crosses back above the red, the trend is still down.







However, things can change. In the world of Dow Theory, all three components bullishly broke above key resistance in mid-April, and have held above ever since. It's old school, but Dow Theory has a long history of reliability and has some high-profile practitioners.








Another chart with longer-term bullish implications is the Cyclical Ratio. It's currently near an all-time high, even as the SPX lags far behind. Relative strength in the Cyclicals is positive for the market outlook.









Market tops are difficult to call, and the reminder du jour is the energy market. Even though USO was throwing off important divergences two weeks ago, it moved even higher this past week -- on even more astonishing volume! It's a great lesson in market mechanics, and a cautionary tale about jumping in front of a moving train.








The significance of what the market does from here depends on your time frame. While a short-term correction in the next few weeks is a decent bet, there are few indications that stocks are ready to collapse to their March lows.

One of the most compelling reasons for this is that stocks with the very best fundamentals have been breaking out to new highs en masse for weeks. The IBD100 has had a thundering performance since mid-March, and has seen an ever-widening group of stocks participating in new highs. This is rare behavior for a rally doomed to failure.

Eventually, the market will sell off, probably to a chorus of "told you so's" and epic QID trade. However, unless investors produce a crop of 4-5 distribution days in a two week span -- and the IBD100 falls apart -- participants will likely step in and buy the dip.

Good luck trading, and I'll write when I can.

best

dk

The dk Report Charts

Calm

After climbing for 6 of the past 7 weeks, the NASDAQ took a breather this week, printing an inside candle on flat trade.

Given record oil prices and broad economic weakness, this is surprisingly sanguine behavior. On a day that investors were forced to wash down AIG detritus with $126 crude, the market logged its 4th lowest trading volume in 2008. Institutional investors continue to be reluctant to unwind their positions, even in the face of withering economic circumstances.

Friday's quiet action was even more remarkable when you consider that earlier in the week, a big distribution day rattled investors. Wednesday's tumble created angst over whether the 7-week countertrend rally is over, or is just taking a break. While it's too early to know for sure, the lack of downside follow-through under stormy conditions is an encouraging sign for the bulls. Adding to the mix, the MID actually closed higher on the week.

The odds favor the NASDAQ eventually testing support -- perhaps down to the blue 10-week EMA on the chart below -- before revealing a clearer near-term path. More than a few days of trading below 2350 would be the kiss of death for this rally.






In a healthy market, growth outperforms value. The ratio chart below measures Wilshire 5000 growth stocks vs. value stocks, and a climbing line is good for the market. This line has actually tumbled off the 2000 top for the past seven years, before finally bottoming in May 2007. This week, as the broader market wobbled, the Growth/Value ratio broke to a new 3-year high. This is a significant development on a flat week, and a sign that new forces are rumbling from within this market.






Energy has become an increasingly crowded trade, and the USO is showing signs of technical wear. As crude vaulted 15% in the past seven sessions, Money Flow revealed the footprints of heavy selling. Trading at a capillary-bursting 59% above its 200-day EMA, even oil can become temporarily mispriced. Got DUG?






One of the most reliable indicators of market strength is the performance of stocks with the very best fundamentals. A handy proxy for this group is the IBD100, and that index added 2.2% this week. Unless a steady stream of distribution days arrives soon, stocks are likely to shake off this correction and continue moving higher.

Until then, have a great weekend.

best

dk



For additional charts and commentary, see The dk Report Charts

Oops

After a steady string of gains, stocks took a plop on Wednesday.

In mid-January, 5-year trend lines were broken signaling the start of a new bear market. Until this long-term damage is repaired, rallies such as the current one are countertrend. This makes them subject to harsh interruptions -- and even quick endings.

It's too early to tell which is now in play. The bears have every imaginable fundamental advantage, but they haven't been able to capitalize on it for weeks. They'll definitely have another shot at it tomorrow.

The 13/34 EMA chart below is one of the classic Bull Market/Bear Market indicators, and it shows the cycle change in January. Until the blue line is back above the red, the market can be a fair-weather friend.






Big volume selloffs like Wednesday's happen in all market climates. Whether the rally is over -- or just taking a break -- is often answered at tests of key support. A trip down to the blue 50-day EMA would be a garden-variety 5% pullback. If that fails, key support is 2250 (a 10% slide). Below that...






Days like Wednesday can be the start of volatility that takes weeks to sort out. Despite its questionable statistical underpinnings, the sell-in-May adage comes to mind as well. How you play a situation like this is determined by your risk tolerance and investment horizon. Regardless of your approach, expect choppy market action.

FYI - no notes on Thursday.

best

dk

The Highs & Lows of Cinco de Mayo

Perhaps it was the tequila, but on Monday, May 5 -- Cinco de Mayo -- there was an interesting series of three posts on the use of the SPX High-Low Index to help time the market. I use this indicator as well, and three posts in one day caught my eye. What struck me is that I apply the SPX High-Low across a slightly different timeframe, and so am adding a fourth post to the discussion.

-- Bill Luby at VIX and More smoothes the High-Low Index with a 20-day EMA to identify intermediate oversold levels and changes in trend. It's a solid approach, a good article, and is one that makes similar observations to my own.

-- Babak at Trader's Narrative uses an intermediate time frame as well, but smoothes with a 10-day MA. Babak posted on the SPX High-Low Index because for him the indicator is currently suggesting caution. While it's not flashing an extreme, Babak senses that the index is nearing an overbought condition. "The easy money has been made in [the SPX] trade."

-- At Investor Village, in a response to Bill Luby, pcyhuang offers an alternative interpretation. It takes the daily readings of the SPX High-Low and applies Parabolic SAR. Since the daily High-Low data are extremely volatile, pcyhuang's version is very jumpy. With unsmoothed, daily SAR settings, this version of the indicator favors short, 3-14 day time frames.

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I found these posts interesting because I discovered the accuracy of High-Low as a Buy/Sell indicator resides more in longer time-frames. In other words, I'd been burned over the years by applying short and intermediate time frames, and found accuracy only after tweaking the time frame longer.

The chart below reveals how a 10-week EMA of the SPX High-Low Index is useful in identifying key, cyclical changes in market trend. The biggest caveat is that High-Low is at its best in picking bottoms, and is dicey at picking tops. At indicator tops, stocks can rally on for months, even as the indicator throws off multiple sell signals. However, extremely low readings provide decent bottom calls.

Over the 6-year period below, the 10-week EMA oscillates in a channel between 50 and 90. You can see that extremely high readings generated numerous false sell signals ( a cross below 90). However, extreme low readings marked both the 2002 and (potentially) 2008 bottom. Crossovers above 50 trigger a cyclical buy.

The takeaway is that the SPX High-Low Index below is currently triggering an important cyclical buy signal for the market, but it remains unconfirmed.

OK now pass the guacamole.

best

dk

Yin and Yang

On a day that Yang and Ballmer (not pictured) are unlikely to forget anytime soon, stocks pulled back on quiet trade yet again.

Except for YHOO, institutional investors showed little interest in unravelling positions built up over the past seven weeks. Monday's action was another example of the stock market's improving behavior, and careful observers of market internals saw these improvements begin weeks ago.

The chart below shows that important positive divergences began developing during the series of lower lows between Jan-Mar. As the NASDAQ continued falling, the number of stocks actually hitting New Lows decreased. At the same time, the number of stocks printing bullish P&F formations steadily increased.

This divergence means that the index declines were being caused by a smaller and smaller number of stocks (mostly financial and consumer). However, this small group of stocks was falling so hard that it was masking improvements in other sectors. Once the toxic selling was exhausted, the majority of stocks assumed control and drove the indexes higher. The climbing New Highs and Bullish Percentage Index are two things giving the rally legs.





Adding to the mix, the indexes now remain parked above important resistance. Despite the well-known fundamental headwinds, the odds favor stocks eventually continuing their climb. It will likely include at least one 3-5%+ pullback, but a variety of internal indicators suggest that this rally could continue for a while.

Until tomorrow, have a great evening.

best

dk

Rotation Ahead

On the heels of a strong up week for stocks, the market cooled its jets on lower trade Friday. This is ideal market action after a surge, and suggests that soon enough, more gains lay ahead.

Adding to the bullishness, all of the indexes except for the RUT are now confirmed above their 200-day EMA for the first time in six months. This is an important development, and is the product of institutional buying, Many mistakes are made on Wall Street, but there are few accidents.

So, after such a run-up, what can possibly push this market higher? Economic data is lighter next week, earnings wildcards continue and risk of credit nightmares persist. Even if the market pulls back next week, the real source of further gains is likely to be something more simple and powerful: good old-fashioned rotation. Investors are selling bonds and commodities and buying equities, and this rotation will likely push stocks higher.

The chart below shows that the 10-year Treasury is a smoking gun behind the recent surge in equities. This was the 7th straight week that the 10-year tumbled, and it hasn't even broken critical support yet. If the Fed is almost done, expect more bond selling, with those proceeds moving into equities.





Commodities are showing increasing signs of wear, and the CRB has formed an unconfirmed double-top. This is accompanied by an expanding bouquet of negative divergences. It's worth noting that the CRB is overweight energy, and this fact distorts the breadth of commodity weakness. You can see this in the CCI chart below. The CCI is equal-weight commodities, and has already made a bearish lower high.






Because the market violated a 5-year uptrend in January, a bear market remains in play. In such an environment, stocks generally rise in jagged rhythms and rallies often end abruptly. The irony is that bear markets also produce the biggest market gains, especially as they come to an end. Unfortunately, few investors are ready when the worm turns, and so the market rises with the fewest number of investors participating.

The best tell for the market's next leg will be bonds and commodities. If selling persists in these asset classes, stocks will continue to rise.

best

dk

The dk Report Charts

Top Ten Myths About The dk Report Hiatus

Over the past eight months, I received a lot of comments, messages and e-mails about taking a break from blogging The dk Report. Most were kind and thoughtful, and thanks to each of you for taking the time to write.

But several were pretty weird. The most unusual of these involved bizarre rumors hatched from the fertile womb of the internet. Below are ten of the best myths I heard about The dk Report hiatus, and all came from actual communiqués sent or forwarded to me.

1. I was not immobilized by clinical depression over the death of Luciano Pavarotti (I received more notes of concern about this than on any other topic. Note to self: never leave an admiring obituary posted on your blog for 8 months).

2. dk was not a pseudonym of Luciano Pavarotti, and the posts did not end because he died.

3. I was not hospitalized for any reason whatsoever, including a heart condition or a grief-stricken overdose of anti-depressants (see #1 above).

4. I didn't stop because Bill Luby and I are actually the same person, and he decided to quit posting under multiple aliases (Bill...you came out on the short end of this stick, and I offer you my sincere apologies).

5. I didn't stop blogging because I lost all of my money a) on a Nigerian 419 scam, or b) refusing to abandon a losing short position on BIDU.

6. I didn't quit because of I took a new job in hotel management.

7. I did not receive a cease-and-desist letter from Becky Quick (you know this is true, because if I had, I would have posted it immediately).

8. scduo4fun and I are not the same person either, although coincidentally he does live just a few miles from me.

9. The decision to quit posting had nothing to do with the Oscars®.

10. My hiatus had nothing to do with Texas barbeque and beer, although I could be persuaded to stop blogging again for enough New Braunfels sausage, Pedro's tamales and Shiner bock (shipping address available upon request).

best

dk

Resistance

The market made it back to critical resistance on Thursday. Both the Dow and NASDAQ have punched through their downtrend lines, but the SPX is parked right on the line.

Friday's jobs number is the likely catalyst for short-term action -- up or down. The market looks prepped to handle a shaky number, but we'll see.

The dk Report charts have been updated, and will continue to stay current.

Good luck trading.

best

dk