One-Day Wonder or Key Turning Point?

Fortunately, we have a reliable way to tell without putting too much at risk -- including missing more upside or risking more downside. I like to pull a page from IBD publisher William O'Neil, and go on confirmation day watch. O'Neil found that he could separate the "one-day wonders" from the important turning points by finding evidence that large institutions had regained their appetites for equities. While there are no guarantees, this method has a very respectable track record.

Historically, that would be evidenced by a significant follow-through rally four to nine days after the first big move up after a longer downturn. Requirements include the major indices rallying 1% to 2%, and on greater-than-average volume, in that five-day window. It opens next Tuesday.

My concerns about the market here have to do with the fall from the postelection trading ranges. As these charts (courtesy of Stockcharts.com) reveal, all the major indices broke out into newer higher ranges in November. The Dow made a four-year high in January. Then the bottom fell out.

1162 - 70 is the key level to watch -- I will buy puts on the Spyders (or short SPYs) at 1160 and cover at 1170

Nasdaq is a trickier chart -- the damage was more significant. The high was 'toppier' and the resistance at 2020 is more formidable

So not only am I watching for the O'Neil confirmation day, I am also watching these prior trading ranges. A return to them would make me very bullish. But since I have been in cash (and not short), these are the sorts of levels that have the potential for massive failures. I would expect to see major shorting take place just below them -- with very tight stops just above.

The areas above and below these ranges offer excellent risk/reward entries for both the long and short sides. That's a relatively rare setup.

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Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].