Farley: Wait for Proof of Turnaround

We should also recognize the influence of short crowding in these narrowly based rallies. There are few deep pockets in these frantically algorithmic market venues. However, there are plenty of short-sellers flipping through their charts and drooling over the precarious positions of stocks linked to the mortgage mess.

These folks jump in boldly, not recognizing the dangers posed by the brutal algorithms pushing these issues through their daily paces. The rapid-fire price movement generates enormous volume by eating up their stops, with real directional movement taking place through overnight gaps or sharp reversals after short-term range expansion.

KBW Banking Index (BKX)

Click here for larger image.

Source: eSignal

Logically, the real test for the banks won't come until the KBW Banking Index (BKX) rallies into the trend line created by the lower highs posted since early 2007. Note how the downsloping line corresponds with the triple lows broken in May. Simply stated, the recovery effort means nothing until the index rallies above that critical resistance level.

By "nothing," I mean don't put a single exposed bank into your portfolio until we see that breakout, because the group remains highly vulnerable to a deep pullback. Yes, I still believe the July index low will hold, but that isn't the same thing as a buy signal. Seriously, these stocks can go nowhere for years and never touch that deep price again.