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Here is the Deal:

We saw an impressive rally on Thursday, but it started after a significant opening gap lower. Thursday’s advance remains consistent with the Dow struggling at the top of its 21-day 2% exponential trading band, which is 12,810 as of Thursday’s close. And a market that remains in a corrective formation.

Don’t let it go down…OR is it…A down tick, what an opportunity. Either way, the Dow is in serious record territory. It is up 20 of the past 25 trading days for the second day in a row. Since 1987, the Dow has accomplished this feat only once before, in November 1995. It is a fantastic rally and at this time it doesn’t seem like it has run its course. I am not particularly bearish; I just like a little zig with my zag.

The expected correction materialized in the form of a negative opening gap. The Dow reached a low of 12,734, just above Wednesday’s low and the listed support zone of 12,700 to 12,720 and never looked back. Thursday’s correction was extremely brief, but it was a correction. 12,710-12,735 remains support. Unless or until that level is broken, it is just a little pullback.

The Fibonacci upside zone is 12,860 with a higher line at 12,885. While it might be reached on Friday, the Dow should continue to struggle holding the gains should they develop. The top of the 21-day band should constrain any rally effort. The bears can focus on 12,785, which if broken will be the first minor warning flag. It takes a break of 12,730 to signal a more serious breakdown is at hand. In light of the relentlessness of this move, it won’t count as a break unless it stays broken for more than a few minutes. The consolidation is three days old and the Dow has not closed down. It usually closed down at least once during a consolidation.

There’s no economic data on expiration Friday. Dow components CAT, HON, MCD, and PFE, report earnings before the open. Once past the open, expiration is likely to play the greater roll. Note: Monday’s following expiration have over the years tended to be down days, though that has not been the case of late. The market remains in the grips of a consolidation that is three days old and I would prefer to see the Dow close down at least one day before calling the consolidation complete. As great as earnings are, the immediate upside should be limited at this point.

Note: Friday 4-20 is a longer-term cycle turn date, technically supposed to be a top.

Here’s why:

The Dow reached a low of 12,734.92 on the open when it was down 68.92 points. That is the worst intra-day decline since the last down day when the Dow fell 118 points. Before that you have to go all the way back to March to find a larger intra-day decline. The Dow rallied 95 points to reach a high of 12,830.08, just shy of Thursday’s afternoon high. It closed at 12,808.6, up 4.8 points. That’s only 21 off the day’s high.

The Dow continues to track just above the top of its 21-day 2% trading band. The top of the ban is 12810 at Thursday’s close and continues to move about 26 points higher per day. Odds of a significant push higher (daily gain > 100 Points) from current levels remain constrained.

While the Dow is ever buoyant, the S&P 500 is showing more of a corrective / consolidation like pattern. It even has the shape of a mini head and shoulders top. However, I think the pattern is more effective in hindsight as they often fail to play out as expected. The neck line is about 1466’ish, in the middle of 1465-1467 support. If broken, it will signal a test of 1460 with potential to fill the gap at 1452. The Fibonacci zone at 1472 to 1476 remains a resistance level with a higher Fib lines at 1481 then 1488.5.

The Russell 2000 did something we haven’t seen in a while; it closed lower for a third consecutive day. With the morning weakness the RUT filled its gap from earlier in the week. At least we have an index that is actually correcting during this consolidation. The RUT held at the 815, just above the Fibonacci line at 814. A close below 814 on Friday will make a fourth down day in a row and could carry a more significant downside message. For now, 814 looks like healthy support.
If the RUT closes near Tuesday’s high on Friday it will leave a rare but very bullish candle pattern.

Like the 2000, the NASD closed down for a third day in a row and filled its gap from earlier in the week. If the Dow and S&P 500 had closed down a couple of days then we would call it a normal consolidation and it would be easier to say the correction has run its course. Unfortunately, we have something of a mess on our hands right now.

The NDX was the only index that took out Thursday’s high to turn its daily trend up. The Dow hasn’t broken the previous days low for over a week. Its daily high-to-high time span is up to 11 days, which is getting long considering average is 6.5 days.
All the 3-day trends can turn down on Friday, but it will take a break of Thursday’s gap open lows to make it happen. Being options expiration, anything can happen but it seems less likely at this time, especially if earnings keep coming through strong.

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth was solidly negative for a third day in a row at -1730. Total breadth has gotten progressively worse each day for the past three days while the Dow’s gains have been +52, +30, and +5. Well, at least we know the weak internals are having an impact. Thursday’s -1700 reading is a solid downside reading; however, since the indices didn’t fall very much, it is a case of many stocks closing down only a small amount.

Total volume was a little better than Wednesday and the market closed lower. Technically we have lower prices and increasing volume, but you have to ignore the Dow to say that. Directionally we are seeing an increase in selling pressure, but not much.

Did I mention the market is overbought? Ok, just checking.

The only internal metrics that are not overbought or really overbought are diverging negatively from an overbought reading relative to the price action. That pretty much sums up the internal conditions.

When applying any internally driven analysis, success is dependent on a somewhat normal distribution of zigs and zags. The market gets overbought and consolidates or corrects. Then it gets oversold and it consolidates or rallies. The action should all be relative to the larger trending conditions. At present the market is stuck on the pleasure button and it won’t let go, which has rendered a terminal overbought condition.

The current overbought condition is significant by many measures. Here is one for the history books. The Dow has closed higher 24 of the past 30 trading days. The last time this happened was December. You don’t remember that rally? Maybe that’s because it was December 1970, 36 years ago. With that thought in mind, expecting a negative close seems reasonable…doesn’t it? For the record, the Dow gained 9.3% on that run compared to today’s run of 5%.

The internal metrics are in the silly zone and when it gets like this, they just don’t matter very much. It won’t reverse until it is ready to do so. History has shown that at best, after a prolonged advance of this nature, a period of flat to slight down prices lasting two to four weeks typically follows. Then the primary up trend can resume. That is the best case scenario. The worst case or most bearish outcome is the market is in a blow off move that will mark the end of an important advance; however, this is the less common development. Odds are, once this run is complete, we will see prices consolidated for a number of weeks, which will be followed by higher prices into the summer.

We are three days into a consolidation that has seen the Dow advance 88 points and it has failed to close down during the consolidation. I was looking for a one to three day consolidation and we have one, though it would have been nice to see the Dow close down at least once during the three day consolidation. Prices may push a little higher Friday or early next week, but the run is extended and the market is acting like it is setting up for a bigger correction. But unless or until an important support level is broken, the trend is higher.

Jim Patterson

Most Obvious chart resistance levels: ()
Dow  12,863, 13,000
SPX 1472, 1475, 1485 Fib extension
NASD 2530, 2543, 2570
NDX 1841, 1852 (high), 1856 (fib) 1877 (minor Fib)
NYSE 9654, 9690
RUT 2K 832, 838, 847

Most obvious Chart Support levels:
Dow 12,,580, 12,480, 12,350, 12,270, 12,180, 12,136, 12,000
SPX 1460, 1448, 1436, 1413, 1397, 1373, 1362, 1340 (50% retracement)
NASD 2507, 2480, 2455, 2425, 2400, 2385, 2335, 2316
NDX 1829, 1808, 1795, 1775, 1755, 1738, 1695 (Fibonacci 38% & Nov 06 lows,)
NYSE 9572, 9470, 9400, 9350, 9280
RUT 2K 818, 811, 803, 790, 760

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

From a pattern stand point, breaking 1840 signals the consolidation is over and a new leg up is under way. Falling below 1820 should signal a more serious down trend is in process.   

S&P 500 (SPX) Trading

>> 3-16-07: With strength on the open it made sense to hold off on the SDS purchase for an hour or so. The SDS bottomed at 60.55, well below the 60.80 I am using as an entry price. We have a full position in the SDS with an entry of 60.80. 3-20 we added another 50% position to the SDS when the SPX pushed above 1407.

100% @ 60.80 + 50% @ 59.60 = Avg cost 60.40.

The SDS closed at 54.70   

Tactical Stock Trading Powered by Patterson Relative Strength

ICLR rec Long 01/24 @ 39.53 stop 34 close, Target >46, closed at 43.02
CBEY rec Long 02/20 @ 31.31, stop 28 close, Target >38, closed at 34.14

3-30 > Long-term Put AAPL October 100 Put Entry @ $12.00 | AAPL closed at: $90.27

AAPL reports on the 25th, after the close. Est = 63¢
ICLR reports on the 24^th before the market opens est = 39¢
CBEY reports on May 3 after the close, est = 9¢

** PRS Open Actives making noise:
Not much going up today.

Jim Patterson
Editor
Tactical Trading Outlook

Here is the Deal:

The Dow finally made it to a new high, above the February high. However, internally Wednesday was a negative day. We are looking for a one to three day correction, possibly longer, and despite the Dow pushing higher today, Wednesday is considered the second day of a multi-day consolidation. A week ago we saw similar activity and the consolidation finished with a single down day for the Dow. It is uncommon to see the same sort of pattern play out in succession, perhaps this time it will be different and we will see two down days.

JPM gives and IBM takes away. Those two Dow components made big moves but for the most part, they offset each other (net -3 Dow points.) It was BA that came to the Dow’s rescue at about 10:15 AM when it shot three points higher adding 27 points to the Dow. Throw in CAT, adding 15, and two stocks account for over 100% of the Day’s gains. With 11 of the 30 Dow stocks up, it is clear this was a divergent rally.

This was a case of 90 gets you 100. When a stock or index comes within 90% of the goal, it usually gets there and the Dow got above 12,795 making a new all time high. It came up about 20 points shy of the Fibonacci target, blame that on IBM (-18 Dow Points.)

After another impressive run of five consecutive higher closes, we are looking for at least one down day. That doesn’t mean I am big time bearish, I just like a little zig with my zag. That said: The higher Fibonacci extension line remains 12,860, but in light of the position of the Dow’s 21-day 2% trading band, it is going to be difficult to get there. Seeing the Dow slide below 12,760 is the first warning signal for the bulls while first support is 12,700 to 12,720. Breaking there will suggest a test of 12,600 to 12,650 in an attempt to fill the gap.

Thursday the Philly Fed report comes out at Noon and is the last economic data point this week. The focus remains on earnings, which for the most part continue to impress investors, and options expiration. Dow components MO and MRK report before the open on Thursday with AXP due to report during the day. Odds of a sixth consecutive up day for the Dow appear slim, but with earnings and expiration, anything can happen. I am still waiting for that elusive second down day for the month.

Here’s why:

Due to a sloppy open, the Dow’s low of the day was 12,728.99 before all 30 stocks were open and trading. The trading low was 12,731 at about 10:15, just before BA sprang higher to eliminate the potential for a down day. The Dow was down 44 points at its low and rallied 109 points to the Day’s high of 12,838.46, a new all time high when it was up 65. However, it closed at 12,803.84, up 30.8 points and 34 off the day’s high.

The Dow continues to track just above the top of its 21-day 2% trading band. The top of the ban at Wednesday’s close is 12,785 and continues to move about 27 points higher per day. This metric tends to contain prices. The point being: the Dow is near-term extended and while it may push higher, odds of a significant push higher (daily gain > 100 Points) from current levels are constrained.

While the Dow continues its unrelenting march higher, the S&P 500 is taking a little break. In the final hour the S&P 500 broke higher after a brief and extremely shallow correction, but in light of the pullback in the final half hour, the slight push higher was likely expiration related. 1475 remains resistance with a minor Fibonacci extension at 1481. Unless or until the SPX falls below 1465, it remains in a consolidation and Wednesday was likely the second day of the consolidation.

While the Dow and S&P 500 don’t seem to go down any more, the Russell 200 is going through a more obvious two day correction as it has closed down for two days in a row. That hasn’t happened since late March. As scary as two consecutive down days may or may not seem, the Russell is holding in a high level consolidation. Seeing the Russell below 820 will suggest a test of the 812 to 815 support area, which will fill the minor gap from Monday.

The NASD was also down for a surprising second day in a row. The NASD spent most of the day in the red thanks to weakness in YHOO. But, that was offset by strength in the Semiconductor sector, led by LLTC and INTC. I am actually somewhat surprised the NDX struggled as much as it did with the Semiconductor group up strongly.

With new all time highs, the Dow is showing buys across the board. The NASD has not reached its all time highs yet, but with both the NASD and NDX so close, it is hard to believe they won’t make it, especially in this strong market. Most indices took out Tuesday’s lows before pushing higher. As a result their daily trends are shown as down. I wrote the program this way because once upon a time, when stocks weakened they would remain weak for more than a few hours.

Detailed Trend Report on Web & CLX Count and Weekly Signal Counts & NYSE & NASD 5-day up and down volume charts

Total breadth was negative all day long. It bottomed at -2000 and recovered, but the highest it got was -289 around 3:30 PM when the indices were at their highest levels. It plunged to -1005 in the final half hour of trading. Volume increased on what was really a down day despite the slight gains for the Dow and S&P 500. Wednesday marks the second day of a correction that has seen the Dow gain 80 points.

The Trin-5 metrics are both below 4, which is extreme. The five and ten day directional volume negative divergences remain while the 5-day RSIs on the listed indices have pushed further into the overbought zone, now above 85. They don’t get this high very often.

Wednesday was the ultimate in waning momentum rallies. The Dow and S&P 500 reached new highs for the move while NYSE breadth was negative, all day long. Breadth for the Dow 30 was 11 up and 19 down, yet it gained 30 points (all from BA.) The market is trying to correct, but it is correcting against a very strong uptrend. Options expiration may be a contributing factor.

I have been harping about the negative divergence of the NYSE 5-day Up and Down volume metrics. The significant negative divergences continue, but on a longer-time frame, there is a recent historical precedent for an upside breakout, after some additional near-term corrective action. It happened last September.

In late August / early September 2006, as the S&P worked back to its May highs, there was a significant fall off in upside momentum. Currently we are seeing a similar situation.

The 2006 event played out much slower than the current situation. In hindsight, I can describe the 2006 event as a situation where buying fell off as the S&P reached an important inflection point at a precarious time. When the market failed to move materially lower, the buyers came in and the rally continued. What this really means is if we don’t see any sort of material correction over the next few weeks, there is a good chance prices run higher into the summer with increased buying as the indices clear out the old highs.

With the market extended to the upside on a near-term basis, a consolidation that is two days old that has shown little in the way of a price correction, odds are we will not see prices move sharply higher from current levels. At this point I am willing to go out on a limb here and say this correction won’t be over until the Dow closes down for a second day this month.

Jim Patterson

Most Obvious chart resistance levels: ()
Dow  12,863, 13,000
SPX 1472, 1475, 1485 Fib extension
NASD 2530, 2543, 2570
NDX 1841, 1852 (high), 1856 (fib) 1877 (minor Fib)
NYSE 9654, 9690
RUT 2K 832, 838, 847

Most obvious Chart Support levels:
Dow 12,,580, 12,480, 12,350, 12,270, 12,180, 12,136, 12,000
SPX 1460, 1448, 1436, 1413, 1397, 1373, 1362, 1340 (50% retracement)
NASD 2507, 2480, 2455, 2425, 2400, 2385, 2335, 2316
NDX 1829, 1808, 1795, 1775, 1755, 1738, 1695 (Fibonacci 38% & Nov 06 lows,)
NYSE 9574, 9470, 9400, 9350, 9280
RUT 2K 818, 811, 803, 790, 760

Here’s where we are now:

NASD 100 Index (NDX) Trading System, trade the QQQQ:

The NDX appears to be in a sideways consolidation within an unfinished up trend.  

S&P 500 (SPX) Trading

>> 3-16-07: With strength on the open it made sense to hold off on the SDS purchase for an hour or so. The SDS bottomed at 60.55, well below the 60.80 I am using as an entry price. We have a full position in the SDS with an entry of 60.80. 3-20 we added another 50% position to the SDS when the SPX pushed above 1407.

100% @ 60.80 + 50% @ 59.60 = Avg cost 60.40.

The SDS closed at 54.60   

Tactical Stock Trading Powered by Patterson Relative Strength

ICLR rec Long 01/24 @ 39.53 stop 34 close, Target >46, closed at 44.00
CBEY rec Long 02/20 @ 31.31, stop 28 close, Target >38, closed at 34.41

3-30 > Long-term Put AAPL October 100 Put Entry @ $12.00 | AAPL closed at: $90.40

AAPL reports on the 25th, after the close. Est = 63¢
ICLR reports on the 24^th before the market opens est = 39¢
CBEY reports on May 3 after the close, est = 9¢

** PRS Open Actives making noise:
No noise today.  

Jim Patterson
Editor
Tactical Trading Outlook