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Jack's Wrap - Another Week Of Solid Action...And At Overbought...Risk Increasing...

Friday February 24th 2012
Another Week Of Solid Action...And At Overbought...Risk Increasing...
by Jack Steiman www.SwingTradeOnline.com

Not that the market did very much this week. It did very little. However, it did hold well considering how long the daily RSI's on many of the major index charts have been overbought. 70 RSI's have been normal behavior for several weeks. They went a few moments below from time to time, but overall the market has been staying overbought. Because of this reality, the majority of people are starting to act as if the market is due for a stronger pullback, but I’ll cover more on that in a bit. With a market this overbought for this long, it makes sense that each day is losing its volatility as the VIX is now well below 20 again. Things can be awfully boring with a VIX well under 20. So little movement.

With the market overbought, it would be best if it sold off some to raise some volatility and to unwind the oscillators a lot deeper. The bulls aren't very willing to give up their shares as it seems there aren't many other places to put their dollars. Lots of excuses for the market to be hanging in at overbought from what I just mentioned, to better than expected earnings, to better economic news.

For now, you simply respect what's taking place and move on. The obvious need for a pullback is clear as can be and will hit at some point, so you don't want to be overly exposed. But playing against the market with aggressive short positions makes little sense. If you need to hedge, you do it with a slow poke of a mover, such as the SPDR S&P 500 (SPY), with a stop at the new clearing of resistance at 1380. It’s a mere $1 loss, but some protection if you want to do such a thing. However, anything beyond that makes little sense, even if it seems as though the market is destined for a strong pullback sooner than later. Some leading stocks look ready to blast lower, but few have made that move to this point. They will in time, but timing it is extremely difficult to do. The market remains bullish, but with a big red flag of caution short-term due to consistent overbought conditions.

So, what are some of the signs that a pullback is getting close in the eyes of traders is something we should explore here. The put-call on the ETF side of the coin is very high these days. Folks are buying a lot of protection to make sure they don't give back too much in terms of gains when the correction finally does hit. The equity side of the put-call ratio is at the neutral level, although a slight bit more slanted to the complacent side with readings in the 70's. Not bad at all, so, no big worries there. Maybe we can feel good about all that buying of protection, but you have to be safe, and good traders know these levels on the oscillators can be troubling to say the least.

The other sign is the look of the iPath S&P 500 VIX Short Term Futures (VXX), and other charts, inverse to the market that are showing some good divergences on their daily charts. The VXX has a double bottom with strong divergences, thus, you have to take notice. It doesn't mean those divergences have to kick in right away, but they do exist and from low levels on their oscillators. So again, you take notice. None of this makes the market bearish at all, but it does raise the caution flag for the very short-term.

One extreme short-term concern I had heading into this week was the rapidly rising level of the bull-bear spread, which had jumped 8% over the prior two weeks. Not good to see the spread moving higher that quickly. My worries were taken down a notch as the numbers came in at 24.5% this week after hitting 29% the week before. You hate seeing over 30%, because once you hit 35%, the market is very close to a major league sell off. With the drop of nearly 5% week over week, some of my concerns have been put on the back burner. It’s nice to see the complacency issue, but take a breather on the side of the bulls. Over 30% and you are most definitely playing for the final crumbs of a move. The risk reward swings heavily in favor of the bears. For now, this is not a concern at all, and some selling from overbought here would probably take those numbers down even further, making it easier to climb right back up once things unwind properly.

The 20-day exponential moving average is now at 1344 on the S&P 500. It has really shot up over the past several weeks. That's always a good thing. However, that's only 1.5% below current price, so a pullback would probably take out this level, but this is a strong bull-run, so no guarantee that would happen immediately or on the first test down. Some initial bounce would almost certainly take place, but it would probably not be very strong in nature. The real key is a combined one. You never want to lose the 50-day exponential moving average, and you never want to lose the breakout, which happened when we took out the long-term down trend line. That level is at 1313 now. The 50-day exponential moving average is at 1311. The same price, basically, holding two key supports. The bears would love to be able to take out either one of those types of support. The fact that they come together at the same price will make the job incredibly difficult for them. It’s a big advantage to the bulls on that front.

So, for now, we move along knowing the bulls are in control, but that there are some real red flags out there for the very short-term. Be appropriate and don't overdo it for now.

Have fun over the weekend. Play with kids if you get the chance.



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