Technical Outlook: Spotting the Real Rallies - TheStreet

The indices bounced back this week amid an extreme oversold condition and a round of government chatter about limiting certain kinds of short-selling.

As a result, the financials got some reprieve from the shorts. When traders are short a stock they must cover their position to close it out. That means they must buy the stock back, which appears to be actual buying when in essence it isn't. It is simply buying to close short positions.

The key to knowing whether a rally in a stock is from real buying or short covering is to watch the action over several days. If the stock starts rolling over and breaking its recent lows, then the rally was probably short-covering. This can also be seen in sectors and the market itself.

My current indicators are pointing to a high probability that the recent rally may have a little more to go, but it was inspired by short-covering. From here, the major indices could possibly move higher by a couple of percent and then resume their primary downtrend. If the market fails to mover higher from here, that will tell us a lot about its internal health.

The action during the next week will be important. Especially key will be to see how the market handles

Merrill Lynch's

(MER)

announcement Thursday that the company had a wider-than-expected second-quarter loss and another multibillion-dollar writedown.

In an act of comedy afterward, Moody's downgraded Merrill's debt. Talk about being ahead of the curve in protecting investors! My question is where were they before this announcement?

As I've been saying, watch the market, because you are not going to get much help from anybody else. In a column earlier this month, I said: "The only way to do that is to closely monitor the actions institutions are taking. That can usually be done quite easily because institutions usually make moves in fairly systematic and predictable patterns.

"The first and easiest way average investors can spot this behavior is by recognizing large volume spikes along with an abnormal move in a stock or sector. That signals a possible change in the current trend of institutional buying or selling."

I pointed out that the basic materials sector looked to be putting in a top, and now that evidence is appearing across the board.

Today, we're going to look at two more situations where the same patterns are developing. One looks like it is topping and one appears ready to move higher. The first is an apparent topping process in the commodity indices.

For this example, I chose the

PowerShares DB Commodity Index

(DBC) - Get Report

exchange-traded fund, which has been in a strong uptrend for quite some time. You can see from the chart below that trading characteristics changed Tuesday when the index dropped sharply on extremely heavy volume. You can also see that prior to that the institutional money stream started plunging.

These signs, along with the wide and loose action of the ETF, suggest a classic intermediate-term top. A break below the 50-day moving average and the $42 support level would be the technical confirmation of that.

To be clear, I still believe we are in a long-term bull market in commodities and oil, but the intermediate term has forced me to take the majority of my profits. I look forward to a much better buying opportunity.

DBC

Click here for larger image.

Source: TC2000

On a positive note, the biotechs seem to be shaping up nicely for an intermediate- to long-term run. You can see that the price of the

iShares Nasdaq Biotechnology

(IBB) - Get Report

has broken out of a six-month base on heavy volume and is currently testing resistance.

If we see some consolidation and possibly a retracement back toward the $80 level, this could be an excellent buying opportunity. However, a break below $78 would signal me to close any positions.

IBB

Click here for larger image.

Source: TC2000

The market is currently in a state of flux, and investors need to keep protective sell stops close on long positions and be very careful on new positions. Take small positions first, and then increase them as they start working.

At time of publication, Manning had no positions in stocks mentioned, although holdings can change at any time.

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;

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