Selling Into Sharp Rallies

 | Oct 18, 2011 | 3:00 PM EDT
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As discussed in last Thursday's column, the 50% retracement of the decline from the May highs to the October lows in the S&P 500 weighed in at 1222.67. Last Wednesday, the SPX topped out less than 3 points shy of that level and promptly plunged 30 points to the 1190.58 level, which, not coincidentally, was less than 3 points above the .382 retracement level of 1187.76.

From there it was up to higher highs on Friday, of 1224.61, eclipsing the 50% level by less than 2 1/2 points. It is now down to -- you guessed it -- the .382 level. This morning's low has been 1191.48, less than 4 points from that level and now it's popping back up again. Already 24 points, or 2%, off the morning lows. The idea for now is to sell into resistance at the 50% retracement level and buy dips to the .382 level or close to it. As I've been saying, I am selling into these sharp rallies. For now, the 50% level is a preferred selling area.

SPX - Stalling at the 50% retracement (again)
Source: optionsXpress

At Friday's close, I sold out my remaining positions in the Rydex Energy Services Fund (RYVIX). I also sold remaining positions in the NDX and cut back in the SPX. Selling into these sharp rallies enabled me to buy the dips. Yesterday, I bought back some SPX positions in the morning and reestablished some positions at the close in the Russell 2000, which was getting slammed. Now, I'm only back to a maximum of 50% invested levels.

The Dow Jones Industrial Average also did its part in calling the turn. Though I didn't show the Dow chart again on Thursday, I had shown it the previous week. Here, the 50% retracement weighed in at 11,640. Friday's high of 11,647 exceeded that level by just 7 points; from there, the Dow has plunged 350 points to this morning's lows. A pretty good haircut.

Dow - Stalling at the 50% retracement
Source: optionsXpress

Of course, the decline may still have further to go. Why not, when you consider the explosive move off of the October 4 lows?

As for downside targets, I'll be on the lookout for another Fibonacci retracement -- this one, a .382 retracement of the rally off the recent lows to last Friday's highs. Though it doesn't have to be seen right away, it's a level that ought to be revisited at some point in the not too distant future. As always, some reason (or excuse) will be given for the selloff. But in reality, it will be the market's need for another standard retracement, demanded by an overbought market. Be on the lookout for the 1167.37 level in the SPX. Whenever it is reached, I will be buying there.

SPX - Short-Term Downside Targets
Source: optionsXpress

As usual, last Friday the indicators gave us fair warning that the market was getting overdone again. The chart of the Market Volatility Index (VIX) below telegraphed another top, just as the usual knuckleheads were congratulating themselves on how bullish the drop below 30 was this time. So, again, they were buyers on Friday as the VIX closed at multi-month lows. A few trading hours later, the Dow was off by more than 200 points. Another great call by the rear-view mirror crowd.

VIX -  Not so bullish at 28
Source: optionsXpress

The McClellan Oscillator closed at a bloated +245 last Friday, which warned, too, that the market was beyond stretched. Even after yesterday's sharp selloff, the oscillator is still overbought at the +116 level, so I am not an aggressive buyer here. Though, as noted, I don't mind reestablishing some bullish positions and returning to 50% invested levels.

Color me still bullish longer term, though a bit cautious near term as long as the market remains overbought.

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