Wednesday, May 25, 2011

A Rare Setup In The SP500 & Qs

I wanted to share this rare setup with you that is occurring in the SP500 and the QQQ right now.  The chart is a weekly chart with the 12 week 2 SD Bollinger bands in cyan.  In the past year there have been two instances of this setup in the SP500, which occurs when the Bollinger bands go completely flat and tight for at least 6 weeks.

Looking back at the SP500 over the last 30 years this setup has occurred very few times, but almost always leads to a powerful move.  The RSI and MACD can both be used to confirm the trend when the market breaks out.  At the moment both are in a neutral condition.

The longest period that I found for this condition was 12 weeks, although another case with some variance lasted 14 weeks.  The current setup is now 5 weeks long, so we may have as many as 7 to 9 weeks more to go, but I doubt it will be more than 3 or 4 weeks.  The breakout is typically in the direction of the trend on the next higher time frame.  The monthly trend is currently a strong uptrend, so the most likely breakout direction is to the upside.

I wanted to bring this to your attention as there is increasing talk on trading blogs and sites about the beginning of a protracted decline.  Even on CNBC, Bob Pisani was airing his concerns that traders are apathetic as opposed to fearful, which might be a setup for a selloff.  The fact is, as I pointed out in my last post, that while trader talk might be complacent, traders are becoming increasingly bearish with their positioning according to the ECPR.  As the consolidation continues I expect the sentiment to become even more bearish which will support a powerful rally for the rest of the year.  This is a change from my earlier view that we would see a top in June.

In this type of environment leading stocks will tread sideways or edge higher as laggard stocks correct.  The simplest thing to do here is to replace positions that are stopped out with new high relative strength stocks.  When the breakout comes it might be difficult to get on board.

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