Watch Your Step Here

 | Dec 06, 2011 | 3:15 PM EST
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As recently noted, the seasonal pattern remains positive. However, the strongest part of it -- and, for that matter, the strongest part of the move -- has passed. That's not to say the market can't continue to move higher. To the contrary, it can and probably will. Still, the S&P 500 moved more than 9% in a little over a week, off the 0.618 Fibonacci retracement level at 1158. After move of that magnitude, it pays to be a bit circumspect in here.

As such, I have been advising selling into the rally, and that's what I have been doing for my accounts. I'm still maintaining a bullish bias, but I'm now invested only up to a maximum of 40% after cutting back a bit in my S&P positions at Monday morning's pricing at Rydex, with the index at the 1265 level. The idea is, first, to look for resistance levels to sell into. Then, if a good pullback follows, presumably to support, I'll use the pullback to add to positions.

For the moment, with the market boxed in by gaps on both sides, I don't really care which way it goes first. If it pops up to fill the Nov. 9 gaps in the S&P or Russell 2000, I will take some additional chips off the table. If, instead, it pulls back to fill yesterday's gap in either index, I will add. It's really that simple. That isn't always the case but, for me, this time it is. I really don't care whether it goes up or down first. I will buy the dip or sell the rally, regardless of the news or the reason or whatever may be the hoopla at the time.

It's noteworthy that the S&P has continued having problems at 1257.58, the 0.618 retracement level of the decline from the May highs, at least on a closing basis.

S&P 500 -- Trouble at the 0.618 retracement
Source: optionsXpress

Last Friday morning the S&P popped up to the 1260 level, but then it collapsed into the close, settling at around 1244. Yesterday it was up to a higher high of 1266.73 (which always makes me wonder who is buying these short-term tops). From there it sold off more than 10 points, closing at 1257.08, just below the 0.618 level. This level will remain short-term resistance until the S&P closes above it. A close above it should mean that the S&P is ready to head up to its Nov. 9 gap at 1275.92. On the downside, there would be several gaps for the S&P to contend with, but first would be yesterday's at the 1244.28 level.

S&P 500 -- Gaps beckoning in both directions
Source: optionsXpress

In the S&P futures, which always provides for a more accurate picture of gaps, the Nov. 9 gap has been narrowed considerably. However, it is still a very visible 7-point gap ranging from 1273.20 to 1266.20. Yesterday's gap, a near-term downside target, is likewise pretty visible, from 1243.50 to 1248.70.

The S&P isn't the only index working on gaps. The Russell 2000 is also banging around between its Nov. 9 gap on the upside, and yesterday's gap on the downside. Here, it's noteworthy that the Russell has been chipping away at its Nov. 9 gap for weeks. Originally it was a big one, ranging from 755.27 to 743.46. But it narrowed a bit on Nov. 11, again Nov. 15, and again Nov. 16. Then, yesterday, the index popped up to 752.71, about 2.5 points from the top of the gap. From there it pulled back about 12 points, below yesterday's low, getting back into yesterday's gap. A pullback to the bottom of yesterday's gap might mark a spot to add to positions for the near term. A return to the top of the Nov. 9 one, meanwhile, would be a spot for me to take some profits.

Russell 2000 -- Almost filling its Nov. 9 gap
Source: optionsXpress

Of course, there are always the indicators, and right now, they aren't very encouraging. The McClellan Oscillator was at oversold extremes a little over a week ago, below minus 300, but it's now approaching overbought -- it settled yesterday at the plus 77 level. That's not helpful to the bullish case.

Nor are sentiment indicators, which continue to reflect too much good cheer. The CBOE Volatility Index (VIX) made a multi-month low last Friday morning at 25.29. We've seen it trade considerably lower earlier in the year. But, at least in recent months, this area around the mid-20s hasn't been conducive to the market's health, as shown in the chart below. So my take on all of this is that caution is warranted, despite the positive seasonals.

VIX -- Not bullish in the mid-20s
Source: optionsXpress

Columnist Conversations

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I reached out last week to my close friend Ken Shreve, who is a prominent writer for the IBD.  I asked Ke...
I reached out last week to my close friend Ken Shreve, who is a prominent writer for the IBD.  I asked Ke...
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