The Week in Crayons

The bulls continued to squeeze the bears this week, capping off an impressive two week rally by printing new highs on on two of our major indexes. While the furious charge to these levels is very impressive, we are very extended here, and are likely due for either a pullback or some sideways chop. This market continues to punish bears, and remains in my opinion a long only environment. While some traders may have had some success in selective shorts recently, in my opinion the highest probability and profitable trades this year have been made buying dips and failed bearish setups. All of the indexes showed some indecision on friday by printing narrow range doji candles, and chasing profits at this point is probably a bad idea as well.

The strength of this rally is immediately obvious when we examine a chart of the Russell 2000 small cap index.

Usually, the behavior in the small caps is a good measure of risk appetite in the markets with strength indicating a “risk on” trade and vice versa on weakness. Well, apparently risk is on as the small cap index rose almost vertically after testing support during the drop we incurred during the tsunami and resuslting nuclear disaster in Japan three weeks ago. We are now at multi-year highs on the index and while this angle of ascent is not likely to hold much longer, if we are truly out of our recent corrective range than our previous pivot high at the mid $830's should now hold as support. Keep an eye on the steep rising wedge as we are likely to break under it at some point next week as we digest this ridiculous move.

The Dow Jones Industrial average had an impressive “V” shaped recover off of the lows we printed in mid march, and impressively rallied to hit new multi-year highs on Friday as well.

While we failed to close above our previous highs, we are now well above all of our moving averages and have several weeks of price congestion below us which should now act as support. Much like the chart of the Russell 2000, the angle of ascent on this chart is extremely steep as well, and we are likely to break below this rising wedge as we consolidate our gains next week as well. Do not chase if we continue to surge higher into next week as the higher we run without consolidating, the lower the probability trades have of succeeding as we become more overbought.

While the S&P 500 has been notably weaker than the two indexes we have just discussed, it still had an impressive run and was able to eclipse most of the price action that precipitated our recent correction.

While the pattern in this chart is very similar to the previous charts as well, it is currently below its previous pivot high and its behavior at that level now becomes critical. If it cannot follow the stronger indexes and breakout to new highs, it will likely drag the others back down as we pull back and consolidate until the imbalance between buyers and seller reaches a new equilibrium. Watch the action in this important index next week as it will likely let us know if we are now free and clear of our corrective range or only testing the upper part of it.

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Posted in Charting & Analysis, Commentary