Ever since March 2009, virtually every time that we have had a market correction it seems as though we have been on the verge of ending the bull run and starting a new phase of the bear market.  Often times, however, just as it seemed as if the bears were about to push the broad indices down through their respective 200 day moving averages, the market would stop on a dime and proceed to sharply turn up on low volume and make new highs.

This phenomenon has been especially frustrating to many traders who were not already fully invested, because they never really got a good chance to reenter.  Many technical traders, in particular, missed out on a lot of those moves higher because they either sat out or decided to go short.  Needless to say, they either missed out on some big profits, or lost a lot of capital trying to go short (or both).  Indeed, the correct play was to simply go along for the ride and chalk the whole thing up to us climbing the “wall of worry” that the early to middle stages of bull markets are so famous for.   It was also correct to dismiss the low volume rallies as being due to the fact that we had a huge gap/vacuum/void to fill from the crash of 2008, which had alleviated a significant amount of selling pressure.

At the beginning of this month, however, several key indices and sectors had recovered many or all of the losses from pre 2008 crash levels.  Because of that fact,  the notion of ignoring the low volume on rallies has become less and less valid. Beyond that, many key leading stocks since 2009 have either become too extended, or have broken down on heavy selling volume.

One trend I am noticing amongst traders is that they have grown so frustrated with trying to short technically weak charts, that they are now using what would normally be their own sound analysis as a contrary indicator.  Instead of going short, they think “I really got squeezed hard the last few times I tried shorting this stock that was up against heavy resistance after a weak volume rally.  So, this time I will go long, even though I know this is a short.”

That kind of thinking can be very dangerous for several reasons.  First off, as I noted before, the market has now effectively filled most or all of the huge gap created by the 2008 crash, so the drift up unsupported by volume argument is weaker than before. Next, to use your own sound technical analysis as a contrary indicator is a mistake because you are allowing the market to throw you off your game–or effectively put you “on tilt.”  The phrase, “on tilt” is a common term used in the poker world, whereby a player loses his cool and changes his playing style for the worse due to a multitude of reasons.

One example of going on tilt would be if you are dealt pocket kings before the flop in a Texas Hold ’em poker game.  You raise, and an opponent goes all-in.  You ponder if your opponent has pocket aces (the only hand that has you beat), but eventually you correctly call, as your opponent turns up pocket queens, meaning you are a huge favorite to win.  When the dealer flips a queen on the board with no king in sight, you lose all of the money you had in front of you.  Despite the painful short term result, you made the correct long term decision. In other words, if you keep making that same decision over the long run, it will be profitable. The odds of another (regular playing) opponent having pocket aces in that situation are not great enough to compel you to fold.

However, you become extremely frustrated from the short term result and think, “Well, if I cannot win playing good cards and making good decisions, then the hell with it.  I am going to gamble it up and play whatever crappy cards I want.”  It is exactly this kind of emotional, knee jerk response that causes otherwise good poker players to go on tilt, and to go broke.

In the stock market, not making those same knee jerk trading decisions based on painful short term results is equally as important, so long as you are making the technically sound decision that is profitable over the long run.

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At the conclusion of the week ending on April 30th, I made a video and annotated a chart detailing why I thought that the Nasdaq was on the verge of a sharp correction. Below, you will find my chart from that weekend.

My point of showing you this is not to gloat that I got the call right.  Believe me, I have made plenty of idiotic “full retard” mistakes just like everyone else.  Rather, I am trying to illustrate to you WHY I got it right.  I was seeing the forest for the trees. Despite what looked like a multitude of bullish earnings reports and improving economic data, the Nasdaq was up against severe, long term overheard resistance dating back to the highs of the post Bear Stearns rally that ended in the late spring of 2008. To not expect a majority of the longs–who had held on throughout one of the most vicious bear markets in a century–to sell when they were finally made whole again, was misguided…at best. Even for those longs who had not been on board for the entire ride, they were still looking at the same weekly chart that I was, and no doubt decided they would sell before every other chartist started screaming to take profits.

The take home lesson is to remember to regularly take a step back and look at the broad indices and sector ETFs.  As fun as it is trying to find small caps that are about to explode or crash, at least seven out of ten stocks move in concert with the broad market.

As far as where we are now, below you will find an updated version of the Nasdaq.

This is where the rubber meets the road.  We bumped our heads up against that spring 2008 resistance and faced heavy selling.  However, we are (barely) holding on to the pink support line that dates back over a year.  Something has got to give. Either we are going to have a huge break out, or we are facing another leg down in this correction and thus we would be breaking down below the multi quarter support line.  Because we are pinned so precisely on that support line right now, I believe it is a good idea to refer back to this weekly chart.

As far as the S&P is concerned, I remain extremely cautious.  While it is tempting for me to become aggressively short here, we are still above the 200 day moving average and thus must give the bulls the benefit of the doubt.  However, I must say the chart has all the makings of a bearish wedge.

The trannies are doing a good job of hanging tough, but the bulls have the difficult task ahead of them in maintaining the uptrend, as the chart below shows.

The small cap bulls are also against the odds here, as the daily chart indicates.

As The Fly mentioned tonight, China is looking horrendous. The ETF looks like that ten day old sesame chicken that you forgot you had in the back of your refrigerator.

Finally, the strongest area of the market has (disturbingly) been the precious metals miners, namely gold. However, the miners are getting close to their all-time collective highs, so I would wait for a consolidation period before entering for anything other than a daytrade at this point.

I hope this post was able to give you a broader perspective of the market as it currently stands, rather than just focusing in on individual names.

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Stocks moved sharply higher today, on the back of the news out of Europe yesterday.  With the $SPX rising 4.40% to finish at 1159, the market is clearly searching for a direction in light of the heavy selling we saw last week.  Despite the positive action across the board today, the daily chart of the S&P does not offer as bullish a view.

While it is a positive for the bulls that we closed above the key 1150-1152 level today,  that area needs to hold over the next few days.   As usual, when fighting for a reversal, follow through is key.  Beyond that 1150 zone, however, the bulls face tough overhead supply above 1160, including the 50 day moving average.  Basically, the concept of overhead supply dictates that many of the longs who bought above the 1160 level and held throughout this recent selloff are highly likely to lighten up if they are made whole, given all of the pain that they endured on the way down.  It is that shift in psychology, from buying the dips successfully since March 2009, to selling the rallies that has me concerned about initiating long swing positions at this point.

If you have not read many of my posts up until the past week or two, I would not blame you for thinking that I have been overly cautious for being heavily in cash.  In fact, I missed out almost entirely on the big move up today.  However, I would urge you to please take a look at my earlier postings here and here, when the market was healthier and I consistently offered many actionable setups.

I am primarily a swing trader, holding for at least a few days or weeks.  My philosophy is to be extremely selective yet also very aggressive when I believe I have an edge.  However, when my analysis shows that I do not have much of an edge, I have no problem backing off from the action until charts reset and offer better opportunities.

Two examples of stocks that were once excellent, high momentum long stocks are $GMCR and $CREE. Let me go on record as saying that I think both firms are fantastic in their respective sectors, and deserved to be in the spotlight for many quarters since March 2009.  However, the price action in both names as of late should be a blinking red light as far as initiating long swing trades in general.  These stocks were the leaders on the way up, and when they start to break down, you had better take notice.

Folks, believe me when I say that I trust the aggregate price discovery mechanism of the marketplace in the leading stocks over what any economist or lagging economic data tells me.  If you want to wear a pocket protector and have your 49th birthday party at Chuck E. Cheese, then by all means go make your investment decisions based on the Calculated Bulging Disk, The Big Liberal Picture, and Zero Friends blogs.

However, if you are serious about making money in the market, then you will focus solely on what the price action in the market is currently telling you.  Right now, we are seeing wild price swings and an elevated level of news driven volatility.  Those facts are not constructive to swing trading with an edge.  By all means, go ahead and trade if you are an expert day trader who is confident that you will not get chopped up.

With that said, there are two possible setups that I am considering in the coming days–$GLD and $SLV. Given the unique nature of the underlying metals to those two ETFs, I am not surprised to see their charts looking constructive.

Above all else, do not be afraid to move to a larger than usual cash position as long as we continue to see these wild price swings.  As exuberant as the bounces may seem, many charts are broken and need time to heal before we should consider making bold bets.  If anything, some excellent short selling opportunities may present themselves soon.

Thanks to everyone who voted yesterday as well as those of you who have read my work, and I am looking forward to us banking some coin together!

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