This column was originally published on RealMoney on Nov. 6 at 11:23 a.m. EST. It's being republished as a bonus for TheStreet.com readers.
charged to multiyear highs in October while the
averages stalled right at their early 2006 highs. There's nothing magical about this index juxtaposition, because blue chips have led four-letter stocks throughout the rally off the summer lows. But this is where the ticker tape gets really interesting.
We've come to the line in the sand that will define trading conditions for the rest of this year and into early 2007. There are just two possible outcomes: Either the Nasdaq will strengthen and join the blue chips at new highs, or the blue-chip indices will fall back into the broad trading range that has contained them over the past three years.
There isn't a real edge in either direction right now, with this divergence firmly in place. Many traders discovered this fact the hard way last week, when a jagged downturn denied profits to both long and short positions. It could be that this twitchy two-sided tape will continue into the year's end and mark out a broad topping pattern.
The good news is we have entered a seasonally favorable time of year. The major indices have moved higher from Election Day into Christmas the last three years. We've come to recognize this odd period as an early January Effect, in which smart money lifts prices ahead of New Year's buying interest.
However, there are no guarantees we'll see a repeat of this anticipatory buying. It's even possible that the bulls have already burned the majority of their year-end capital. On the other hand, it's also foolish to expect substantially lower prices in the next two months despite growing evidence that we're headed for a hard economic landing in 2007.
Institutional money managers struggled mightily with performance during the first half of 2006. They're not about to let their recent profits slip away from them. This urge to lock in yearly gains as early as possible could build compressive options activity that keeps the major indices within tight boundaries until the beginning of January.
I expect a sideways market that undermines momentum strategies in both directions. I expect that money will be made during this period by exceptionally good stock-picking skills and tight stop-losses. The question is, what stocks and sectors should outperform between now and the year's end?
At a minimum, look for capital to exit market groups that led the summer rally and into issues that aren't overstretched to the upside. We saw one aspect of this rotation last week in the upside burst of commodity and energy stocks.
The gold recovery in particular has captured everyone's interest.
streetTracks Gold Shares
rose almost 5% last week in its best performance in several months. Unfortunately, the 2006 chart for the popular instrument doesn't show a clear-cut path to higher prices.
Note the broad triangle carved out since the May high at $72.76. This pattern shows five waves, which often precede a sharp move higher or lower. However, the sharp downward angle of the upper trend line raises the likelihood that it will need more time to absorb overhead supply, so the initial burst off the October low may already be nearing its end.
The pivots to watch on the next downtrend lie at the 50-day and 200-day moving averages between $58.50 and $59.50. These levels could offer substantial support for a follow-through rally that reaches the May high in the next few months. In any case, look for seesaw action that rewards long-term positions and frustrates short-term speculators.
It looks like crude oil is carving out a bottom between $57 and $60, but it's still too early to buy the broad energy sector. In particular, oil service stocks are giving mixed messages as they recover from their midyear downturn. Fortunately for traders and investors, the
Oil Services HOLDRs
has marked out well-defined levels that should issue actionable signals in the next few weeks.
I call this pattern "the rock and the hard place." The exchange-traded fund broke three-month support when it gapped down in early September. It remounted this key level about four weeks later, triggering a "failure of a failure" signal, but it's now stuck below five-month declining highs resistance.
A rally over the trend line at $140 would be a buy signal, while a breakdown under remounted support at $130 would be a sell signal. Traders should stand aside until one side breaks, because the odds are evenly stacked between the two outcomes right now.
I favor the upside here, but I see no reason to risk any capital until this volatile instrument proves itself.
At the time of publication, Farley held none of the stocks mentioned, although holdings can change at any time.
Alan Farley is a professional trader and author of
The Master Swing Trader
. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;
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