Technical Analysis
Despite Bullish Talk, the Charts Tell a Darker Story
 By Mark Manning
RealMoney.com Contributor
5/9/2008 4:17 PM EDT
URL: http://www.thestreet.com/p/rmoney/technicalanalysis/10416110.html

The market bounce that we had on Thursday brought all the talking heads back onto the airwaves, saying how quickly the market rebounds after a selloff. Today I am hearing on the business channels that the early morning selloff is quickly being supported by buyers.

Although commentators and investors are becoming increasingly bullish and say that the bottom is in and that we are due to move higher, this position just doesn't stack up to the overwhelmingly negative signs that my internal indicators are pointing to.

I've been talking about this recently in my columns over the last couple of weeks, and last Tuesday I said that the positive outlook and excitement are appearing while the major indices are hitting major resistance levels. I stated that my main concern was that if we broke above the 1400 level on the S&P 500, that could be a bear trap, and we could quickly reverse lower.

I continue to believe that the recent move has a high possibility of being a fake-out, because, as the indices have moved up, breadth, volume and relative strength have weakened. The other negative divergence is that as the S&P 500 has moved up, institutional net buying has been making lower highs. This means there's less money flowing into the market as it moves up.

In March I said that the S&P 500 would likely move up into the 1400 to 1450 resistance area. Now that it has reached that level, I do not like the way that my technical and sentiment indicators are responding. First, you can see that the rally is forming a bearish wedge, and with that happening right into resistance, there's a high probability of a sharp break to the downside.

If we do see a break to the downside and the 1350 support level doesn't hold, there's is a good chance that we could eventually take out the March lows. This is not to say that investors should start shorting the market and hoping that that will happen, but they should be aware that the risks are dramatically increasing.

From a fundamental standpoint, earnings season is coming to an end, and the market is entering its historically weakest months of the year. The Federal Reserve has made its moves, and there are not many more catalysts at this point to move the market higher, especially if oil prices continue to increase.

Click here for larger image.
Source: TC2000

Readers know that I closely watch the percentage of stocks above their 40-day moving average. When the green line moves up into the red zone, it points to a high probability of a change in direction in the market. Currently, it is very near historical highs.

Click here for larger image.
Source: TC2000

The American Association of Individual Investors' bullish ratio is also nearing extreme highs, showing that individual investors are the most confident since the market rally last October. That was right before the market went into a sustained slide. When you see a move up into the 50s on this chart, it is usually not a good idea to become overly aggressive.

Click here for larger image.
Source: TC2000

The chart below is showing that traders are very optimistic and that there is low put volume relative to call volume. This happens when individuals believe that the market is going to continue much higher. The equity put/call ratio is the volume of puts divided by the volume of calls traded on individual equities on the CBOE (Chicago Board Options Exchange) on a given day.

Click here for larger image.
Source: TC2000

When the market is nearing intermediate-term or long-term peaks, small investors become overwhelmingly speculative, and that is another significant signal that the risk in market conditions remains high. Below, you can see that the Nasdaq/NYSE volume ratio is currently above the upper band, and that is bearish for stocks going forward.

Click here for larger image.
Source: TC2000

The following two charts represent the great work that Marty Chenard over at StockTiming.com does on market sentiment. The chart below shows the daily buying and selling by institutions. The blue boxes around the blue line represent institutional buying activity. No. 1 shows the pattern for last October when the market hit its peak and sold off. No. 2 is where we are now, and it is showing the same pattern.

Marty stated that this same scenario happened last October as institutions let the market move up by not selling off their holdings. But at the same time, they bought just enough to sustain the buying by the masses. And then they stopped buying, and they started selling.

Concurrently, we're seeing the same type of action by institutions, and that could possibly mean that they're ready to reverse their positions and go into a selling mode. The one thing that could change this outlook would be for the institutional managers to change their position and begin aggressively accumulating stock. That doesn't look likely at this point.

Click here for larger image.
Source: TC2000

The chart below represents the Institutional Index of core holdings. This institutional Index of court rulings is very important because it represents over half the market's volume and has a very heavy influence on the market.

Marty developed this index because institutional movements track better technically than other indices. For example he states that "on Oct. 11, 2007, the institutional 'core holdings' index hit an exact 61.8% Fibonacci retracement while the other indices did not. That day marked the exact top of the market. Note the previous, clear up channel and the down channel we are now in."

The index currently remains in a technical downtrend and it has had a double resistance technical level. Technically, resistance levels like this can mark a significant turning point in the market.

Click here for larger image.
Source: TC2000

When risk increases, as I believe it is doing now, this does not mean that you go out and aggressively short the market or sell all of your long-term holdings for fear of a crash. It simply means that you should take some profits off of the table and use logical money-management by being more conservative and set protective stops underneath higher-risk positions to protect your capital. That will give you the much-needed capital to buy back if there is a significant correction from this point. If it doesn't happen, you still have cash to buy solid stocks that meet your investment criteria.

Mark Manning, AAMS, is an Accredited Asset Management Specialist and Registered Investment Advisor with Butler, Wick & Co., where he specializes in wealth management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Manning appreciates your feedback; click here to send him an email.