Index Advisor 002
1/8/2007 8:27:23 AM

Recommended Trades:

We are not making a trade recommendation at this time.

Open Positions:

The Index Advisor currently has only one open position, which is:

We are Short the SPYders (Amex:SPY) at $141.40, entered on Wednesday, January 3rd. Set your stop just above $143.00 to avoid that round number.

This position was entered as a swing trade, with the swing high at $142.86, so an intraday move above that level should negate this trade. Note that a close above $142.00 will break the downtrend line drawn through closes since December 14th, and we might chose to exit the trade if this should occur.

Overview

Trading action has seen an increase in volatility in the holiday shortened week. That volatility comes with a downward bias on the NYSE and an upward bias on the NASDAQ. Volume has been increasing, with the heaviest days being to the downside, so the market may be at a tipping point and we believe investors should be ready for a correction.

With earnings season starting in the coming week, but with more significant earnings reports beginning the week of January 15th, there will be plenty of catalysts to move the markets.

At this time, we believe many investors have been using rallies to lower their downside exposure and that they will continue to sell into rallies, stifling the markets ability to maintain a prolonged rally at this time.

To understand more about our view on the markets, we will have to look at the charts.

Market Climate

The market finished its last two days of the Santa Claus rally in mixed fashion, with the NASDAQ heading higher, and the NYSE selling off. Friday saw a broad-based retreat across both the NASDAQ and the NYSE and the sentiment seems to be one of concern.

With down volume being greater than up volume for the last weeks, there is some concern now of a correction being imminent.

The U.S. stock market composite chart:

When we look at the chart for the US Composite, we see what appears to be the start of a new move downward. The market actually hit a new intraday high on Wednesday, the second to last day of the Santa Claus rally, and then began to sell off, closing on the 20-day moving average. Thursday's move opened from below the 20-day moving average while trading back up to it. Friday's move lower challenged the 50-day moving average but closed above it. It closed on the lower Bollinger Band. The question traders will be asking themselves is, will the market begin to walk that band downward, or will it bounce back up?

While markets tend to have an overall bullish bias (markets inevitably rise over time), it appears that there is a lot of concern over the extended rally we have seen over the last six months. With greater volume coming on a downward bias, we would wait for a reversal of a leading indicator before we would take a long position.

Now, let's take a look at the charts for the major indexes.

A look at the chart for the Dow Industrials is represented by the Diamonds ETF (Amex:DIA).

Abbreviations and color key appears below:

Note the following order is Red, Yellow, Green, just like a stop light, so it might be a helpful mnemonic:
Thick Red line represents the 200-day simple Moving Average, (200DMA)
The yellow line represents the 50-day simple Moving Average, (50DMA)
The green line represents the 20-day simple Moving Average, (20DMA)
The light blue line represents the 3-day Moving Average, moved forward three days in time, (3x3MA)
The thick blue line indicates the exponential 13-day Moving Average (13DMA)
Bollinger Bands are abbreviated as BB. There is an upper and a lower Bollinger Band that varies in distance from a central moving average (shown as light red/pink) based on the volatility of stock price movements.
RSI stands for Relative Strength Index. It is an oscillator, which can be used to determine how overbought or oversold a stock may be.

The DIAmonds rebounded from horizontal support on Friday, but have broken below their long term uptrend line and their 20-day moving average. With key support (the 50-day moving average and the lower Bollinger Band) about one dollar below, a break down her of more than that would really see downside action getting started.

It's too early to tell whether the DIAmonds will get a bounce here or support will be broken. With the all time high close a bit more than one dollar higher that Friday's close, any rally would have to overcome that in short order. On the other hand, and break down more than about one dollar below would likely see a move of several dollars downward before finding support.

The S&P 500 ETF, known as the Spyders (AMEX:SPY) is shown in the chart below:

The chart for the SPYders shows the beginning of a downtrend move with a break down below the lower Bollinger Band on Friday, which followed the break down below the long term uptrend line. Volume has been increasing with a bias to the downward days. With the 50-day moving average just below, a test is likely. If this test succeeds in breaking through that level, it is likely that a more dramatic move down to the $137 level could occur, in order to test the 100-day moving average.

Friday's downward moved touched the 100% Fibonacci projection, so a reversal to the upside is not out of the question. However, it appears that there is a bearish bias that may encourage a further move lower, even if there is a bounce initially from this Fibonacci level.

This week's NASDAQ 100 ETF (QQQQ) Daily Chart is below:

The QQQQs have put in an important candlestick pattern that indicates a braking of the upward counter trend move, and perhaps a reversal to the upside. The Hirami must be confirmed but suggests that the up trend may be at an end at this time.

The QQQQs are sitting back above their 20-day and 50-day moving averages. On Friday, the candlestick pattern was a Hirami. This indicates a braking of the countertrend move upward, coincident with the Santa Claus rally, a move that started the first trading day after Christmas and continued through Thursday, the last day of the traditional Santa Claus rally period.

Thursday's big move up was impressive with investors chasing what appears to be under valued tech names. With some of those gains given back on Friday, the jury is out on whether the bulls have the commitment to move the markets higher in the short term.

The choppiness indicator shows the down ward trend has been arrested and the market is currently consolidating. Markets can consolidate sideways or move up or down.

Conclusion:

True to form, the markets completed the Santa Claus rally period nominally bullish, with the NASDAQ making a better showing, but even the NYSE did move up to some degree. Thursday marked the last day of the Santa Claus rally and Friday's move ended the week with a bearish tone, with the S&P-500 finishing lower than the gains seen during the Santa Claus rally period.

With all the major indexes having broken their long term uptrend lines, we are looking for another challenge downward. Some indicators are showing oversold levels, so a bounce here is possible.

This coming week is the beginning of earnings season, with the significant start the week of January 15th. Earnings reports generally move the markets so look for more trading action to get under way shortly.

Regards and Good Trading,