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Technical Outlook: Stay on Guard

If you want to take a chance on the market, ETFs could be the way to go.

Investors have certainly been witness to economic and market history in the last month.

The recently approved financial-sector bailout turned out to be a buy-the-rumor, sell-the-news event, as traders pulled their chips off the table after the plan was put into place.

I have stated that this is pure market manipulation by the government, and trying to force the market higher won't benefit investors in the long term. The markets need to be free to do what they want and work out the excessive problems so that we can clean the system out in order to get a solid bottom.

Steps did need to be taken, but protecting poor management and bad decisions by way of government intervention is not the way the market works, and somebody is going to have to pay the piper in the end.

Trust me, no one who wants to see the resurgence of a bull market more than I do, and that's why I am so against this type of manipulation, which will likely only drag out the primary downtrend even more.

That said, we have had a panic selloff, and the fear level among institutional and individual investors is as high as I have ever seen. Some of my sentiment indicators are hovering at historic extremes. The negativity is even higher than it was after the 9/11 attacks.

I've been studying bull and bear markets for many years, and even though I know there are more problems out there, I don't think the negativity can get much higher than it already is.

The recent selloff may have traced out a short- to intermediate-term low over the last week that could produce a strong bear market rally. But be aware, the market is still in a primary downtrend, and I have seen nothing that comes close to indicating that that is coming to an end. However, I am finding that my indicators are at extremes, and the steep decline is producing interesting opportunities.

That doesn't mean I'm ready to dive back into the market, but since I've been mostly in cash through this entire decline, I'm going to start approaching the indices using ETFs. Waterfall sell-offs in bear markets can produce tremendous profits, but they can also be very volatile.

In order to prepare, I can set protective sell-stops directly underneath the recent lows. The key will be to take small positions at first and build as prices continue to hold above the lows.

Now, let's take a look at the internal health of the market.

I often use the percentage of stocks above and below the 40-day moving average as an overbought/oversold indicator. When the indicator is up into the red zone it's often times to take profits and expect at least a short-term correction. When the indicator is down in the low teens, it often presents a very good buying opportunity.

Currently, so many stocks are trading below the average that the reading Thursday was 2.54. This panic reading is well below any other level over the past 18 years. These types of readings only happen when investor sentiment is at extreme lows and often suggests major market bottoms.

What I like about this week's move is that we came close to testing last Friday's low and then reversed sharply higher. Thursday was a follow-through day to Monday's move higher. Volume also increased above the last two days of selling.

The same action is occurring in the Nasdaq. The waterfall decline that ended last Friday moved up two days and then retraced back down near those lows. This appears to be a successful test, as the index followed through to the upside.

In conclusion, there are not many stocks are even close to having attractive bases to buy off of, but you can use ETFs on the indices to play any bounce higher. However, I would be ready to take profits at or near the 50-day moving averages.

Risk in the market remains very high, and more financial problems aren't out of the question. From my research, the government's bailout plan isn't going to be enough to support the underlying problems in the financial sector. However, the historic levels of pessimism could certainly lead to a very sharp bear market rally that could last for several weeks.

Keep protective sell-stops underneath all positions in the case of a further market meltdown. During volatile times, smart money-management rules are also necessary.

I move back incrementally into a tough market. That way, if the indices continue to hold above the panic lows, I can systematically add to my positions. If things change and they begin to sell off, I can quickly liquidate without taking heavy losses. Continue to keep a high level of cash until we get confirmation that the follow-through move is real.

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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