Trading Signals

Overall, the sentiment cold be considered positive for tomorrow's trading session. The Nasdaq 100 has broke its January 22nd high which could be considered as a good confirmation of bullish sentiment. S&P 500, DJI and Russell 2000 are close to break their highs as well.

Another positive sign that would favor bulls on the current stage is that the last two trading sessions' up-move did not generate any strong volume surges and we did not see any high advance/decline readings on the NYSE Composite and S&P 500 indexes. Therefore, we may assume that there are no overbought signals despite strong rally up we had during the last two days.

Another bullish sign is the decline in volatility which is usually associated with confident and positive trading of the bulls.

US Dollar continue to rize

As I mentioned over the last couple of days: with volatility at these high levels, we should be ready to strong and sudden swings. High Volatility always have been a sign of mid- and longer-term bearish mood. On Sunday in my "Side Way Trend on Indexes" post I have pointed to the few signs that suggest dominance of mid-term Bears. Lets see if they will be able to break the low seen on November 16, 2010 on the S&P 500 and Nasdaq 100 - DJI's low was broken yesterday. Or it will be another session of strong swing at the morning and then side-way trading for the rest of the day (as we had over the last two weeks).

US Dollar index is up, and it looks like nothing will hold it from moving higher to the August 2010 levels. Stronger dollar is another force that support bearish trading.

I'm moving from 15- and 30-min harts to the 5-and 15-minutes time-frames. One of my rules is to lower time-frame on higher volatility or reduce bar period settings.

US Dollar Up - Stok market Holds the gain

It looks like I was wrong and the indexes did not pulled down, but moved side-way. the money flow an all intraday time-frames is positive. Third time the S&P 500 and DJI are coming close to their highs seen on November 18 and November 19. If those highs are broken, the odds could be good we may see indexes running up to the highs seen on November 5th. Under those conditions, I would set tight stop-loss for short position.

US Dollar index has recovered from today's morning negative trading, yet, indexes manage to hold the gain and did not dropped. This is not good sign for Bears as well.

Right now, I'm on 15- and 30-min charts. Money Flow on the 15-min charts started to decline (yet still in positive area). Lets see if the 30-min money flow follows it.

Bear in mind that the volatility level is high and we may see sudden strong moves.

Another point worth mentioning is that we have extremely strong Bullish Advance/decline reading. On Nasdaq 100, all 100 stocks are traded above their yesterday's close. Advance/Decline readings on the S&P 500 and NYSE composite index are at very high levels as well. In many cases such strong readings could be seen before strong down-turns.

Beginning of Bearish Market? or just short-term correction?

We had first week of clear decline since beginning of September. It was not a strong decline and this decline did not generated any panic (we did not see any strong volume surges to the price decline). However, this decline has pushed many technical indicators closer to the bearish sentiment on the longer-term charts (1 bar = 1 day and higher time-frames).

Smaller time-frame charts, on other hand, have some bullish signals. Such, on 15-min and 30-min charts I may see money flow trending toward positive area. Yet, these time-frame are short-term and they cannot generate signals beyond tomorrow opening. From these charts I may say that there is some odds that we may see positive trading tomorrow. Big bearish volume surges on the Nasdaq 100 on November 11-12, 2010 may point to possibility of bounce up as well. Again, the Nasdaq 100 index was the only index that has strong bearish volume during the last two trading session. Therefore I would not rely strongly on the Nasdaq 100, right now.

As I already mentioned, 1-day and longer-term charts are moving toward negative sentiment. Hourly charts are bearish. This is another reason, why positive signals on the intraday charts should not be considered as strong signals.

Tomorrow, I'll be watching 15-min, 30-min and hourly charts. If the indexes follow the signals on the 15-min and 30-min charts and we see up-move then I would be watching hot it may affect money flow on hourly charts. I think US Dollar index it worth paying attention as well. If it goes up and breaks October 19 and 27 highs then it could generate another wave of selling on the stock market.

Keep in mind that over past week we see some increase in volatility. If we see further increase in volatility it may mean that the current movement down could grown into a strong correction.

Money Flow and Volatility

We had up-swing at the market open and then decline as I expected yesterday. However, around 11am the indexes started advance as US Dollar started to decline. If you compare today's US Dollar Index and S&P 500 index you will see that their trends are exactly opposite. As I already mentioned several times, it looks like current stock market investors are looking at US Dollar trend.

Regarding money flow: the money flow continue to stay negative on the hourly charts. Today's advance did not greatly affected it. On 30- and 15-min charts it have became positive (I have mentioned yesterday that I would watch these charts). Yet, on 5-min chart money flow is becoming negative again.

Overall, from the money flow prospective I would say that the main sentiment(hourly chart) continue to be weak, in addition we may have decline tomorrow at the market open (5-min chart). If this happen and we see change in the flow on 15- and 30-min chart he we may have some strong decline.

Other things to consider is :

- The ETFs already dropped after the market close and index emini futures are already traded down. So most likely we will have weak opening tomorrow.

- The US Dollar index is close to its high seen on October 19 and on October 27, 2010.If this level is broken many traders may consider that the US dollar is not any more in down-trend. It could be additional fuel for stronger decline on the stock market.

- There are not a lot of economic reports, so most likely the trend will be guided mostly by technical analysis over the next couple of day (should not be surprises).

- Over the last couple of trading sessions we have an increase in volatility. I'll be reducing bar period setting on most of my intraday technical indicators to avoid a situation "when it's too late"

US Dollar ans S&P 500

As I mentioned a week ago in my "Strong Volume" post on October 16, 2010 "if market is predisposed to reverse its trend it does not mean it will happen tomorrow. It could happen tomorrow, yet, we still may see a week or even two weeks of side-way trading." - since October 13, 2010 the S&P 500, DJI, Russell 2000 and other indexes could be considered in the side-way action. The Nasdaq 100 index could be considered moving side-way since October 18, 2010.

As I commented over the past week, this side-way trading was supported by very strong increase in volume and was very volatile. It is not a common thing to see such huge trading volume at the top. As a rule, at the resistance levels volume surges are smaller and more prolonged in time, while at support levels volume surges are very strong. I have scrolled index charts over the past 10 years and I was not able to find any occurrence of such strong increase in daily volume on the S&P 500 and DJI history. Some similar, but smaller increase in volume was noted in period from April 14 until April 19, 2010 when the indexes were traded at the same high levels. My neighbor would say "There's some serious sh... is going on that market"

The critical point on mine view is that on last trading day of the week (Friday, October 22, 2010) volume was down to its normal level. The volatility was down as well. I would even say that volatility was very low, "like a silence before storm".  I have already mentioned on Friday (see "Low Trading Volume" post) that such decrease in volume and volatility could imply that the period of movements in investments positions of "Big Guys" could be over; which could mean that the next week could show who won (Bulls or Bears) and whether the market (S&P 500, DJI and Nasdaq 100 indexes) will be trending up or down. Conservative traders who does want to spend a lot of time on technical analysis could simply wait when either October 19th low or October 21st high is broken and then make a trading decision.

On the other hand I will not be surprised to see the market at the same level next week. The Election Day is coming and I do not think that some political leaders would like to see any type of crash or strong move down right now. In 2008 the stock market crashed too deep down. I was always under impression that the market was over-pushed down artificially by some "Big Players". This is why we had in 2009 very strong recovery in short period of time. In 2008 the stock market played on the hand of some party and it looks like now it is helping the same guys. But this is another story, I'm not a politician and I do not play conspiracy games - it may drag away from "cold-blooded' and unemotional analysis. Just in some cases, some weird market swings could be very difficult to explain from the prospective of technical analysis.

Coming back to the technical indicators I would say that

 - The daily charts remain to be bullish, yet I see strong overbought signals, especially on the volume based technical indicators. The volatility on daily charts is going up, which is usually  happened before Bear markets.

 - The hourly charts have mixed signals - some indicators and some indexes are bullish and other indicators and indexes are bearish. The common thing between all indexes on hourly charts is that all of them have overbought signals.

- 30- and 15-min charts could be considered slightly positive: you may see some positive Money Flow, however at the same time you may see negative divergence in the Money Flow.

 - Smaller time-frame, after Friday's quiet trading, is very neutral, yet, I would say that some indicators have tendency to become negative.

Note: by referring to volume and advance/decline based technical indicators I refer to MarketVolume charts. See NYSE, Nasdaq 100, S&P 500, DJI, Russell 2000...

It is worth mentioning that US Dollar index has generated number of oversold signals and many technical indicators on this index indicate bullish sentiment. If the US Dollar reverses and moves up it could be as trigger for the stock market to go down. At the current moment I focus some on mine attention on dollar simply because over the last three month the S&P 500 index trend is chronically opposite to the US Dollar index trend. It's like some invisible hand is trying to direct the stock market by using US Dollar.

Chart #1: The US Dollar and S&P 500 index daily chart with elements of technical analysis applied to the US Dollar index

Money Flow

15-min charts are turning bullish which increases the odds of indexes moving to the October 18th highs. So far, money low on the 5-min, 15-min and 30-min charts could be considered positive. Money flow on hourly chart is still could be considered between neutral and ngative.

The first hour of trading went on high volume and most likely second hour will be on strong volume as well. High volume and high volatility during an up-move suggest weak up-move and I do not expect to see strong up-move today. Yet, anything could happen.

US dollar index is down and it helps bulls.

S&P 500 Chart

Another mixed week. The S&P 500 and DJI indexes moved higher while the Nasdaq 100 moved in side-way trend in which this index has been since September 24, 2010 (right now only a few points higher). The S&P 500 an DJI indexes were mostly traded side-way (since September 24 as well) with exception of the strong rally on October 5, 2010. Currently, the Nasdaq 100 index moves at its high levels seen in April 2010. The S&P 500 and DJI indexes are still 2-3% below their April's highs.

Below I have posted daily chart (1 bar = 1 hour) of the S&P 500 index with plotted Nasdaq 100 index (orange line).

Chart #1: The S&P 500 daily chart with elements of technical analysis

The technical analysis on the chart above is applied to the S&P 500 index. The DJI daily chart would give quite similar picture. The Nasdaq 100 daily chart would be slightly different , with a little bit more bearish sentiment.

By summarizing the indicators above I may say that the longer-term positive divergence on the SBV and advance/decline oscillator is a good sign from the longer-term prospective. However, there are several negative signals at the current moment:

 - the SBV is still at high positive levels and is moving sideway. Even bullish volume accumulation could be considered quite strong and would indicate oversold index's condition, the Money Flow is still positive on the S&P 500 and DJI (not on the Nasdaq 100). Until we have positive money flow there are always will be good odds of up-move

 - Advance/decline volume and issues ratios and McClellan Oscillator are moving sideway after being at high levels. This suggests that if in September we had traders buying advancing stocks then, right now, there are not as many traders focused on the positive stocks as before. The number of traders focused on the declining stocks is about the same as the number of traders that are trading rising stocks. This shift from trading positive stocks suggest that many traders switch into bearish mood and if this tendency continue we may see more traders in bearish mood.

- We have a signal on the MVO. This suggests an increase in bullish volume (bullish volume surge). As a rule such increase in volume during price advance may lead to the shift in supply demand balance (when power of buyers become existed) with further reversal down. However, if you scroll the history you will see that usually reversal occurs when MVO returns to zero.

- The biggest concern on my view is an increase in volatility. The volatility is up since its low readings in the middle of September 2010. This is not normal. I have not see a lot of periods in the history when indexes moved up on rising volatility. The volatility is not too big to be considered strongly bearish, however the fact that is up from its low readings suggests nervous and uncertain trading, which is usually seen during down-moves.

Overall, I would say the the indexes could be considered predisposed to move down and we already may see some bearish signals. Which is logical when the indexes are at their Aprils highs. After a month of positive trading we may expect quite strong reversal. However, until wee see some negative money flow it could be too risky to play on it. If correction down meant to bee strong then there is no need to play at the top. More conservative approach would be wait for conformational signals and ply confirmed trend.

Unsertain Sentiment on High Volatility

It was a quite volatile session today: opening at high, then swing down, then swing up, then decline, then recovery. At the end of the day the indexes are where they were yesterday. The indexes did not continued the up-rally we had on October 5th, yet at the same time the indexes do not rush into correction.

From one side it is difficult to believe that 2-3% correctional move down (mostly side-way trading) we saw at the end of September would release the market (indexes) from the overbought condition the indexes should be after September's bullish trading. From other side it is harder to break bullish sentiment into correction than bearish sentiment.

I think many technical analysis are betting on the S&P 500 and DJI hitting their highs seen in April 2010. Maybe it is were they are going, however, I do not like volatility. If you check daily charts, you will see that such up and down swings are very often noted before strong declines.

Increase in Volatility

It was a volatile week. Strong opening on Monday, then tree negative sessions in a row (Tuesday-Thursday) and then again strong opening on Friday which basically made the past week positive. Even the Tuesday-Thursday's move down is quite shallow it is the strongest one since the beginning of September.

I'll try to be short this time. From one side my technical analysis suggests that the indexes are overbought and we may see some strong move down in the future. From other side we still did not see any confirmation signals of beginning of such move. Additional negative sign is that the past week has brought increase into volatility on the longer-term chart.

My expectation from the coming week are neutral. If we do not see strong decline on Monday, then I would expect to see side-way trading. Even if we see decline, I would expect the indexes be above September 23's low in side-way action.

Index Trading

side-way trading on the S&P 500 and DJI indexes and eight straight in a row positive trading sessions on the Nasdaq 100 index - this is what we have by the end of the week. There is quite different picture on other indexes. As an example, the Dow Jones Utilities (^DJU) index is already in the correction down since September 9, 2010.

Overall, we have not seen negative moves on main market indexes over the past week. However, the same as I mentioned in my few previous posts, I would say that intensity is growing.

Some points to consider, which I think are important.

• The advance/decline issues and volume ratios are moving down on all three indexes (Nasdaq 100, DJI and S&P 500). On the DJI and S&P 500 indexes the advance/decline ratio is already negative. This indicator tells that the majority of stocks are already in decline. The indexes are not down because of the strong earnings reports and strong moves on some big companies (one company make 5% up and five companies make 1% down each - you have index flat).
•  We had big bullish volume surges on many indexes over the past couple of trading sessions. The strongest bullish volume surges were noted in the insurance and internet market sectors. Such surges indicate that big institutional traders make a decision to fix profit at the top and sell big number of shares to greedy retail investors. Personally, I would stay away from the investing into insurance companies, especially by knowing that the Government is putting hand on the health insurance which will take away some profit from the insurance companies.
•  Taking into account big bullish volume accumulation on many indexes over the past two weeks, the stock market could be considered overbought. The indexes (Nasdaq 100, S&P 500 and DJI) did not have any noticeable correction over the past two week.
•  We have negative divergence on many technical indicators - when the price moves up and make new highs yet an indicator does not make new highs. As a rule this suggests changes in the stock market sentiment.
•  All over the media you may hear positive news, like there are no negative news at all - this is a negative sign for me. I consider it like attempt to manipulate sentiment of small traders and make them buy while "big boys" (who invest big and who express opinion on news) are dumping.

Some positive signals

• Longer-term volatility is down - this is a positive sign.

In summary, I would say that that technical analysis suggests that the market is predisposed to move down. Some indexes and market sectors are already in decline, yet, main market indexes are still at the top. My opinion is that we may face bearish trend, yet I could be wrong. If the market is predisposed to move down it does not necessary mean it will go down - we still may see side-way trading. A conservative trading strategy could be waiting for confirmation signals before investing.

P.S. Some interesting quote from the news - something negative that is not strongly highlighted in the media: "Regulators on Friday shut down three Georgia banks and one each in New Jersey, Ohio and Wisconsin, boosting to 125 the number of U.S. bank failures this year … The number of bank failures is expected to peak this year and be slightly higher than the 140 that fell in 2009. That was the highest annual tally since 1992, at the height of the savings and loan crisis. The 2009 failures cost the insurance fund more than $30 billion. Twenty-five banks failed in 2008, the year the financial crisis struck with force; only three succumbed in 2007."

Nasdaq 100

The indexes continue to move almost flat, with exception of the Nasdaq 100 index. It looks like the indexes are ready to go down, yet they wait until the Nasdaq 100 collect more overbought power.

The are two interesting thins happened today.

We had extremely strong volume surges in the Nasdaq Insurance and Nasdaq Internet market sectors. Keep in mind that this is sixth positive trading session in a row on the Nasdaq 100 index. These surges in the Nasdaq sector indexes would push the Nasdaq in stronger overbought condition.

Another point worth mentioning is very low volatility by the end of today's session on all indexes. I have already mentioned several days ago in the "Volatility Down" post (on September 9, 2010) that such drop in volatility is considered as "The Squeeze" and very often noted before sharp and strong swings. In addition, such low drop in volatility is very unusual in period of futures expiration - this Friday we have options expiration, futures expiration and index options expiration ("Triple Witching Week").

Volatility Down

As I mentioned in my previous post ("Trading Strategy" post on September 5, 2010): "it is still difficult for me to believe in strong recovery (Yet, I could be wrong). Because of that I would not be playing long at this moment. At the same time there are no bearish signals and because of that I would not be playing short either" - the past week has gone mostly under side-way pattern with some positive bios.

By taking look at technical indicators, I may say that majority of them continue to be bullish and suggest possibility of further development of up-move. However on many technical indicators you may notice negative divergence - when price makes new high, yet an indicator does not makes new highs. Such divergence in technical analysis usually signals change in the sentiment with possible reversal in the near future.

Another point worth mentioning is that the volatility has dropped over the past week. While volatility still remains high on daily charts (1 bar = 1 day and higher time-frames), on lower time-frame charts (hourly charts and lower) we may see substantial drop in volatility. Overall this could be considered as a positive sign. At the same time sharp drop in volatility (also known as "the Squeeze") could be nicely seen on Bollinger bandwidth on hourly chart. Such Squeezes to the volatility lowest levels are usually noted before strong and sharp moves.

The third point I would like to drag your attention to is that the indexes (S&P 500, Nasdaq 100 and DJI) came close to the resistance levels seen in the middle of January 2010, in the middle of June 2010 and at the beginning of August 2010. No doubt that this level is sensitive to mid- and long-term traders and mostly their sentiment would define the further trend.

Overall, I would say that we may see some strong moves in coming days. Because of the negative divergence and overbought indications on the shorter-term charts, I would expect to see some correctional move down. Since we do not see strongly overbought indications on the longer-term charts, it is difficult to say at this point of time whether this correction (if it occurs) could grow into stronger down-move.

Trading Strategy

Last week in my "Side-Way Trading" post I mentioned about a possibility of short-term up move, yet, I was skeptical about strong up-move. It appeared to be that I was wrong. We did have a strong up-move. One more time the stock-market has proved that sooner or later everybody makes mistakes in analysis and stop-loss strategy should be used not just to cut losses but to protect profit as well.

During the last four positive sessions the indexes (Nasdaq 100, S&P 500, DJI, etc) have come close to their June's and Augusts' high levels. So far, the odds are good (from technical analysis prospective) we may see the indexes third time at those levels. Twice the stock market (indexes) has bounced down from these levels and most likely we may see slow down again.

Majority of technical indicators continue to be bullish and as I already mentioned, the technical analysis suggests that we may see the indexes moving higher. There are only two negative sings from my point of view.

First thing is high volatility level. The stock market continue to be highly volatile and this is a bearish sign. In such volatile market we could have strong down move in the same short period of time as we had the current 4-day up-run.

Second negative thing, from my point of view is that the market was not strongly oversold, yet it did make strong up-move in short period of time. It is more like some institutional investors came back from vacations, they saw stocks cheaper than a month ago and they started to buy. What is going to happen when their buying power became exhausted?

Because of these two points above, it is still difficult for me to believe in strong recovery (Yet, I could be wrong). Because of that I would not be playing long at this moment. At the same time there is no bearish signals and because of that I would not be playing short either.

One of the rules in my trading strategy is staying in cash until I see a pattern. I missed the last up-move - I did not lose money on that, I just did not make as much as I could. Still, the fact is that I missed this move and now it is better to stay in cash in order to avoid another mistake. My view on the current stock market condition is that I would expect to see indexes at their June's and Augusts' high levels. Then, depending on how those levels are hit (is they are hit) I would built further analysis.

Volatile Markets

I mentioned a week ago in the "Trading strategy" post on August 8, 2010: "even I more bearish (because of negative divergence I see on many charts), I would say that (as in most cases of side-way trading) a simple strategy could be used.... If lower line of side-way corridor (low on August 6) is broken - odds would favor the bears." - this is exactly what happened on August 1, 2010 - the lows were broken and the indexes continued to decline.

Now, majority of technical indicators are bearish and suggest good odds of further decline. Yet, as it always happens in case of technical analysis - there is always something that points in opposite direction.

In the current situation, on August 11, 2010, the strong decline has generated great bearish volume surge. In addition, on that day we had extremely low advance/decline volume and issues readings. If we compare August 11 to July 16, we will see that even smaller bearish volume has pushed indexes up. Furthermore, there is still a possibility that this volume may cause up-move. At the same time, from the bears prospective of view we may say that volume and advance decline signals on August 11 were too close to the recent highs to consider them as strong bullish signals. Another point is that even we had extremely low (extremely oversold) advance/decline reading in the S&P 500 and DJI sectors, the NYSE composite advance/decline volume was not even strongly oversold - yes, it was bearish but not strongly.

Overall, I would say that the odds of the further decline are higher. However, taking into account volume surges and low advance/decline reading on August 11, the one who is in short may consider setting a stop loss to protect a profit already earned since the time when August 6’s lows were broken.

Another aspect that should be considered (on my opinion) is that the volatility level is still high, which means that we may see sudden and strong reversal, therefore it could be recommended to monitor charts daily.

P.S. It does not looks like we have quite summer vacation trading...

Volatility

As I mentioned a week ago in my "Volatility, Volume and Economic News" post (on July 24, 2010): "results of my technical analysis suggest that the stock market ... is quite weak, unstable which and may reverse into another down turn" - we had volatile and overall negative week. Yes, the stock market (S&P 500, Nasdaq 100 and DJI indexes) only about 1% down from the previous week close, yet, we saw quite negative trading over the past five trading sessions.

There are three specific factors that should (on my opinion) be paid attention to. First one is an increase in Volume, second one is increase in volatility and the third one is that the indexes (see my "DJI Chart" post on July 4, 2010) are close to their previously seen resistance levels.

From one side an increase in volume during the decline on July 29, 2010 could cause the indexes to move up. The high volume is quite noticeable in the Nasdaq 100 and S&P 500 sectors. Taking look at this as well as at the fact that we saw change in the money flow on July 30, 2010 a technical analyst may assume that we may see  some up-move reaction on that "strong selling". From other side, not all indexes had strong bearish volume surges (surges during price decline) on that day. At the same time by going into the higher time-frames we may see that the volume increase is not as strong as it looks on intraday charts. Another factor is that even these bearish volume surges were noted during the price decline, actually, they occurred not far from the resistance seen on July 27, 2010.  From this prospective, I would say that my technical analysis suggest that we may see some up-move however I would not expect it to be very strong.

The volume leads us to the second factor - increase in volatility. We saw frequent changes in the trend over the past week (especially last two trading sessions). This is a bearish sign. It's not good to see increase in volatility close to the top. Very often it could mean that institutional traders (traders that invest huge amount of funds) are trying to sell at the top yet they cannot sell everything they have because they do not want to create selling pressure and they do not want to push stock market down before they dump what they want to dump.

Overall, I would say that you may find a number of technical indicators that suggest possibility of up move. My technical analysis tells me that this possibility exists as well, yet, so far, I do not see the indexes gonging higher their June 21st and July 27th highs. From the mid-term prospective, last five trading sessions could be considered as side-way trading with increase in volatility. At the same time longer-term charts indicate more bearish signals. Because of that I would expect to see some development of bearish trading and I would monitor charts more closely during the trading hours to see confirmation of that on intraday levels as well.

Volatility, Volume and Economic News

It looks like the summary I posted last week in my "Leading and Lagging Indicators" post (on July 18, 2010) was confirmed by positive trading week. In that post I stated "Overall, by summarizing all of the above, I would say that if I would be in short, I would think about closing short position or at least about setting a stop-loss to protect profit. I would not rush into a long trade (majority of indicators are still bearish) and I would monitor index charts closely for possibility of changes in the sentiment toward bullish trading.". Already on Monday (July 19) some technical indicators started to generate bullish signals an already on Tuesday majority of them became Bullish.

Taking a look back at the past week I cannot say that this is that kind of up-move I expected. As a rule, an up-move is less volatile than down move, yet, past week's price advance is an exception. If you take a look at volatility indicators on daily chart (1 bar = 1 day) you will see that volatility went up. From technical analysis prospective, this is not good sign for bullish trend. Another negative sign (on my opinion) is that the past week's up-move was supported by increase in volume which was especially clear in the Nasdaq market. This is not like healthy up-move looks like. Even the stock market moved up as I expected last week, because of the volume and volatility, I do not believe in a strong recovery toward April’s highs.

Another point that makes me cautious is the reaction of stock market on the economic news and reports. I do not analyze economic reports and I do not base my trading decision on the economic reports. However, I monitor how stock market reacts on them. The last week has been enriched by good quarterly profit reports as well as by other economic news. The market did not react strongly positively on these reports, yet it did not miss smaller bad news. This would not be a characteristic of a healthy up-trend as well.

In summary, because of the increase in volatility and volume as well as because of the weak stock market reaction on positive economic reports, I would stay on alert about further up-move. Of course, if I see further advance which would be supported by decline in volatility and volume then I may change my opinion. Yet, so far, results of my technical analysis suggest that the stock market (Nasdaq 100, DJI and S&P 500 indexes) is quite weak, unstable which and may reverse into another down turn.

It does not mean that I am rushing into short position. The indexes are still on their up-side and there is a good possibility that we may see further advance. However, I would monitor charts closely for changes in the sentiment. When volatility is high changes could be fast.

Leading and Lagging Indicators

By following my "Index Trading" post on July 10, 2010 where I wrote "In summary I would say that I see number of factors that favor further up-move." we basically saw positive trading at the beginning of this week.

Then in my "Increase in Volume" post on July 13, 2010 I stated "At this moment the majority indicators continue to be bullish and, personally, I would expect to see positive and sideway trading during this week." and then in my "Nasdaq 100" post I mentioned "Yet taking into account increase in volume I may expect a slow down of the current recovery, and at leas a side-way trading - then we may see how it develops.". As it happened, we had 2 trading sessions of side way trading (July 14-15, 2010) and then strong decline on the last day of the week (July 16, 2010).

Now, the main question is whether the stock market (Nasdaq 100, S&P 500 and DJI) indexes will continue their drop, or there could be other scenario. Below, I tried to summaries some points that on my opinion may help in understanding possibilities of further trend development.

1. The Friday's drop down was very strong. The Dow Jones Industrials dropped on that day by 2.8%. The stronger DJI bearish trading last time was seen on June 29, 2010 and on June 4, 2010.
2. The indexes were only two trading sessions in side-way trading at the top before that decline (June 14-15).
3. During that decline we had very strong oversold advance/decline readings (in both issues and in volume)
4. During that decline we had strong output of the bearish volume (very high trading volume).

All four points above would recommend that this is could be logical healthy drop down to release some overbought pressure collected over the 8 positive trading sessions in a row on the Nasdaq 100 ( 7 positive sessions on DJI) and now, even we could have some further decline the odds could be good that we may see indexes back to their June 13-15 high levels.

The Bearish points are:

1. Majority technical indicators show bearish signals.
2. Volatility is increasing.

Leading indicators (volume and advance decline based technical studies) signal that the stock market (indexes) is predisposed to bounce up. However, most of the lagging technical studies (price based indicators) are bearish.  The high volatility is very important factor on my point. Because of high volatility we may see strong and sudden changes in a trend when most of the technical indicators (due to a lag) would generate signals when it's too late to open/close position. High volatility also suggest that the market is still weak and even if we see bounce up, if the volatility does not go down, there will be a possibility of developing of another down-move.

Overall, by summarizing all of the above, I would say that if I would be in short, I would think about closing short position or at least about setting a stop-loss to protect profit. I would not rush into a long trade (majority of indicators are still bearish) and I would monitor index charts closely for possibility of changes in the sentiment toward bullish trading.

Nasdaq 100

Last week in my "Too Far Too Fast" post (on June 20, 2010) I have mentioned following "The trading volume over the past week was low (actually regular) which would not indicate greedy buying. I do not want to tell that this is the end of the recovery. We may see some drop down and then further run towards new highs. There is a possibility of such scenario and technical analysis points to that at this moment. However, if "big money" do not believe in strong recovery, for me it's difficult to believe in it either. Furthermore, I would be cautious and monitor stock market sentiment more closely."

It looks like not just me but the stock market in whole did not believed in strong recovery - starting from June 21st (on the next day after my post) we have been moving down.

If you take a look at the daily index charts (Nasdaq 100, S&P 500, DJI, etc) you may notice that the recent move down was relatively quiet. We did not have extremely low advance decline sentiment readings, we did not have increase in volatility and we did not have substantial increase in volume. In summary we may say that 4-5% drop over the past 5-6 trading session did not generate any panic on the stock market and this is not how a down-move usually ends.

If you take look at history - check the volume at the bottom of down move in the begging of October 2009, at the end of October 2009, in January-February 2010 and most recent on May 19-21 and on June 4-9 - you will see that all moves down are marked at the end by a strong increase in volume (volume surge). The current move down did not bring a lot of additional volume. We had only small increase in volume on June 24-25 and we have basically side-way trading since then.

Mainly because of the steady volume, it is difficult for me to believe that the current side-way trading may grow into a recovery. Majority of technical indicators continue to remain bearish. The Nasdaq 100 is maybe the only index that shows some small oversold condition. The disturbing thing for me is quiet trading (no increase in volatility during the recent decline). It sounds like a "silence before storm".

Another Crash

As I mentioned in my previous post (see "Short Technical Analysis" post on May 31, 2010) "If we do not see up-side reaction on that volume tomorrow or the day after tomorrow then I would consider a possibility of retesting the Lows seen on May 25, 2010."  - we had side-way volatile trading at the beginning of the past week with strong decline on Friday, June 4 of 2010.

The Friday's decline wiped out almost all gain of the past two weeks. Now we are getting close to the May 25th bottom.

As with majority of the strong declines, the indexes (Nasdaq 100, NYSE Composite, DJI, S&P 500, etc) have generated strongly oversold signal: strong increase in volume during decline (volume surges) and extremely low Breadth (advance/decline) indicators readings. From one side these oversold signals indicate panic selling and possibility of shift in supply and demand balance which could lead to a bounce up.

From other side, we had too many similar signals (7 by my count) over the past month. In majority cases we had bounce up after such signals, however, all of them were short lived and the indexes are still at the bottom. Another negative factor is the high volatility level. We do not see a decline in volatility which tells that the stock market continues to be very sensitive and we may see any time other strong declines.

It is difficult to believe that we are going to face another stock market crash or strong recession. I would rather say that in period from March 2009 until April 2010 the stock market went too far and too fast (it was driven by institutional speculators and not by economy). The economy does not develop so fast and now it could be a time to level it up.