Resistance Will Stop a Real Rally - TheStreet

Resistance Will Stop a Real Rally

Don't get her wrong: It's not that the Chartist wouldn't like a rally. It's just that stocks are most likely to rally into resistance right now. Talk about it on our message board.
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Oct. 19, 1999

There were certainly a few very short-term positive divergences in yesterday's action. For example, despite the midday selloff to lower lows in the

Dow

and the

S&P

, there was a contraction in stocks making new 52-week lows. Of course, we can explain that away due to the rally in the financials because they've been the ones leading that statistic. But that would be making excuses for the action, and it's best if we let the action speak for itself. So chalk one up for the positive side.

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There were a few other positive divergences yesterday as well: While the Dow was making a new intraday low, the

Dow Jones Transportation Average

was not. Neither did the

Dow Jones Utilities Average

, despite the rise in interest rates. OK, so there are two more positive divergences to post on that side of the ledger. Oh, and I guess we should also add the bounce off support at Dow 10,000 and the 1230 area on the S&P.

Of course, the first step to a real bottom is when the stocks, which led us down, begin to hold. The problem I have with this is that the financials and transports, two of the worst groups, have done this before and it has turned out to be a one-day wonder. Should these two groups actually hold at higher lows for longer than a few days, I would have to give them credit for more than an oversold bounce.

So why don't I sound excited at the prospect of a rally? Because for the most part there has not been enough work done on the downside to warrant a decent rally. There are so few bases in the individual stock charts that a sustained advance just does not seem possible at this point. And without a decent amount of basing, it is likely stocks will rally right into resistance where they will meet sellers yet again and thus return to the downside.

Let's take

IBM

(IBM) - Get Report

, for example. We can see how the late August rally failed just pennies shy of the early July high. That would be the first thing this stocks has done "wrong"; it didn't make a new high along with the DJIA. Then it began sliding, slowly at first. It even bounced off that 120-support area for a day or two. Then around the 112 area, it managed to break a one-year uptrend line dating back to last October's low. That 112 area also happened to be some short-term support for the stock. (Due to the way the program captures the chart, you will be unable to see last year's October low and the break of the uptrend line.)

So now the stock has held at 104 since last Wednesday. Typically I would say we should give that stock some credit for not sliding along with the market on Friday. But instead, I worry about the next rally. The stock has now made a series of lower highs and lower lows. And I can see layers of resistance overhead quite clearly: the first around that 112 area and, more important, at 120. That's the type of action we see when a stock is forming a top, not when it's forming a bottom.

When stocks have that much resistance overhead, it takes a long time to eat through it. The very first thing these stocks need to do is hold at higher lows, not go to lower lows. So it takes a rally to the first layer of resistance, where it backs off, comes down and hopefully holds at a higher low (if it doesn't hold at a higher low the process must start all over again). Then another rally attempt may take it to the next layer where the same thing happens again. This type of action goes on until the layers of resistance have been worked through. It is standard for this process to take months, not days or even weeks. That's how bases develop. When we see this sort of action in many different groups, we can then forecast a sustained move on the upside. But until we see that, the resistance looms overhead.

As I thumb through the chart book, I am hard-pressed to find many stocks with bases. I have pointed out

Wal-Mart's

(WMT) - Get Report

base before and still believe that stock has a target in the low 60s. But I can't seem to find much in terms of group confirmation among the retailers. I have mentioned

Kellogg

(K) - Get Report

so often that you are likely sick of it, but it is a base. While not as interesting as Kellogg,

General Mills

(GIS) - Get Report

is OK, too. Also,

Sara Lee

(SLE)

in the food group. Of course, no one seems to like the food group much, so these stocks are still pretty underowned.

These short-term positive divergences may just lead us to another rally in here. However, I suspect that rally will be no different than all the ones we've seen since July: short-lived and unsustainable. When there's been more work done on the downside and we can point to stocks with bases, I will believe in the upside. For now, it appears the resistance overhead is more powerful than the support below.

Helene Meisler, based in Singapore, writes a technical analysis column on the U.S. equity markets on Tuesdays and Fridays, and updates her charts daily on TheStreet.com. Meisler trained at several Wall Street firms, including Goldman Sachs and Cowen, and has worked with the equity trading department at Cargill. At time of publication, she held no positions 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. She appreciates your feedback at

KPMHSM@aol.com.