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Stock Market Rally Isn't Over

The stock market is overextended, but the Fed and a falling dollar will ensure that stocks continue to rise through the U.S. elections.

NEW YORK (

TheStreet

) -- The stock market rebounded Wednesday, posting a light-volume, broad-based rally. Although light volume tends to have a neutral to upward bias on stocks, it was mainly the sharp drop in the dollar that spurred stocks and commodities higher.

Wednesday's bounce was not much of a surprise for several reasons:

  • The overall trend is up; one-day selloffs are generally profit-taking.
  • Panic selling on the NYSE tipped us off that the market was oversold.
  • I don't think the Fed will let the market fall before the November election.
  • The intermediate cycle is turning up this week; there are three weeks of upward momentum.
  • The dollar remains in a downtrend overall. The Fed is likely to continue to hold the stock market up into the election by printing money, which devalues the dollar and boosts stocks and commodities. While everyone is trying to pick a top in this overextended market, I think it is crucial to stick with the overall trend and avoid fighting the Fed. Using the key moving averages on the daily chart as shown in the charts that follow, continue to buy on dips until the market closes below the 20-day moving average. Then you should abandon ship.

Dollar Index: Four-Hour Chart

The dollar put in a big bounce this week, filling its gap window. Remember that most gaps get filled with virtually every investment vehicle, so when you see them remember this chart.

SPDR S&P 500 ETF: Daily Chart

The

S&P 500

, as represented by the

SPDR S&P 500 ETF

(SPY) - Get SPDR S&P 500 ETF Trust Report

has been riding the key moving average up, and Tuesday's selloff tagged the 14-day moving average along with extreme market internal readings, telling intraday traders that a bounce is about to take place.

Gold Futures: Daily Chart

You can see gold has done much the same. There has been a sharp profit-taking/stop-running selloff, which took the price back down to support. We took a long position to catch this bounce and -- we hope -- a larger move going forward.

Market Sentiment Readings

Tuesday's pullback was a great reminder of just how overextended the equities market was. These kind of high-volume selloffs are typical of bull markets.

Without regular pauses in price, traders tend to place trailing stops, moving them up each day. Because they're chasing stocks higher instead of waiting for a pullback, we get a very large number of stop orders following the price up each day.

But it's only a matter of time before a key short-term support level is broken. Then everyone's stops turn to market orders, flooding the exchanges with sell orders. This is exactly what happened on Tuesday, which I show in the chart above.

TheStreet Recommends

Knowing how to read market internals provides great insight for short-term traders who want to make high-probability trades. Although they're only part of the equation, market internals are very powerful.

We bought both of Tuesday's intraday extremes in our

advanced chat room

. We quickly booked profits and moved our stops up in order to protect our capital as the market surged higher.

Get my free reports and trading ideas here

.

--Written by Chris Vermeulen in Collingwood, Ontario, Canada

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Chris Vermeulen is founder of the popular trading sites www.thegoldandoilguy.com and www.ActiveTradingPartners.com. There he shares his highly successful, low-risk trading method. Since 2001, Chris has been a leader in teaching others to skillfully trade in gold, silver, oil and stocks in both bull and bear markets.