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March 29, 2009

Extreme Trading

The rally that just keeps on ticking seems to be faltering. Price gains are decelerating, volume has been waning rapidly, and the market faces historic extremes in overbought conditions. There are those that will profess that at the beginnings of major rallies, much like the ends of major declines, the market will ignore indicators and keep pushing higher. True. Nevertheless, I have a hard time believing stocks can push much higher in the near-term. There are numerous sign of buying exhaustion:

stock market indicator

stock market indicator

As a testament to the historic volatility this bear market has served up, two of the three times the MCO 10DMA has risen above 70 have come in the last three months. The two previous instances... July 2004 and January 2009... both resulted in immediate sell-offs, but of differing degrees. In 2004 the market was in the midst of a long, choppy correction within a bull market. The sell-off which ensued from the extreme MCO reading took the correction into its final low before the bull market resumed its course. The 2009 instance, we are all familiar with: a 30% dive into the March low.

Of course, it is natural for oscillators to reach historic highs as a market comes off the lows of a historic sell-off, and as we all know, extremes can often become more extreme. However, we can at least recognize the fact that these readings are historically stretched and be on the lookout for other signs that the market is ready to correct. Let's have a look at the S&P 500 itself:

stock index chart

The last eight sessions have seen volume wane rapidly as stocks moved higher. The SPX also broke through a downtrend line that could use a back-test. I'm going to suggest that we get that back-test... perhaps in conjunction with the retreat to SPX 740 we've contemplated... followed by a new push higher. So, we have new information, but the plan remains the same: wait for a correction of our 3-week rally and add to longs if and when we see some healthy buying-on-weakness data.

Moving on to precious metals, I can't say I'm thrilled with the fact that gold lost its trend line:

gold chart

Gold bulls should now hope we are just in the midst of a A-B-C correction. If the second down leg pairs the first, then $850 should provide support. If price loses $850 in any material way, we bulls will once again have to grumble and pout.

Oil appears destined to rally to its 175DMA:

oil chart

As long as energy remains bullish, I suspect the stock market will remain firm, corrections aside. However, if oil continues up through the moving average, the results will be destructive for an already-weak economy and thereby eventually disastrous for the stock market.

 

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