A Rally Frothing at the Mouth

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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Volume was relatively high on Nasdaq yesterday, but the price action went nowhere. Churning action like this is not a good sign and indicates lots of people are selling as other people are buying. As soon as the buyers get less enthusiastic, the selling pressure will drive the market down. This is only one of many hints that the current rally is heading for some trouble. The other obvious ones are the put/call ratio, overextended stocks, gaps, and resistance. There is also plenty of bad economic and corporate news waiting to be released and although the market has been ignoring it lately, at some point it will start paying attention to it again.

The put/call ratio is a contrary indicator and is only significant at extremes. It has fallen into the 0.5's range, not too far above the low for the last year, which is above 0.4. This level of put/calls indicates an excess of bullish enthusiasm and that traders are taking on too much risk. Still it is not impossible for the put/call level to hit a new low for the year and even if it that occurs, it doesn't indicate that the market rally ends the next day. It does mean the rally is getting long in the tooth however.

The market is also full of overextended stocks and there is extensive gapping going on. Once a stock starts to rally (let's define a rally as beginning with the 10-day moving average crossing the 50-day and staying above it), it is important that the price doesn't get too far above the 10-day moving average, nor the 10-day moving average gets too far above the 20-day (after it too has moved above the 50-day). The statistical phenomenon known as reversion to the mean is likely to kick into action when this occurs. The stock price will want to go back to the 10-day or even 20-day moving average (see a 3-month daily chart of HWD for a good example of this). The situation becomes ever more precarious if the stock gaps up while it is becoming overextended. This has happened not just once, but two or three times for some stocks lately. The market likes filling gaps and this adds another impetus for driving a stock's price down.

You need to keep an eye on major resistance areas. The Nasdaq is having trouble going higher because it is stuck at its 200-day moving average for the moment. The Dow and S&P 500 still have a way to go to get to theirs (currently around 9000 and 950 respectively). When they do, the entire market could start having trouble moving up. At the very least choppy action is likely to follow, if not an outright drop in the market (if it doesn't happen sooner, it will happen later).

If you have been in the market for the last month or more, you should have some nice profits. Don't let them disappear. Put stops below your positions or sell them if they have been going up too far, too fast and you have large profits.

NEXT: U.S. Unemployment 15.8%; Grade Inflation on Bank Stress Test

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21


This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.