Wednesday, July 7, 2010

Oversold Bounce? Still A Downward Trend?

Market players have been waiting a couple of weeks for it, and today we finally had the much-anticipated oversold bounce. There was a little hesitation early on, but, as we continued to hold and made new intraday highs, the shorts covered and the underinvested bulls were more aggressive with their chasing.

Historically, all the biggest gains of the market have tended to be on an oversold bounce. The biggest upside moves occur in bear markets and downtrends, because market players aren't positioned for them. The shorts are overconfident and squeezed, while the bulls have idle cash they need to put to work. The end result is action like we had today.

Breadth was almost 5 to 1 positive, and the point gain was substantial, but volume was mediocre. In other words, it looks like a dead-cat bounce. However, if you paid attention to the action from the bottom of March 2009 to the top in April 2010, you are very aware of how often those sorts of bounces just kept going and going.

Since the top in April, we had another day that was very similar to today, and that was following the flash crash. The S&P 500 bounced 4.4% on May 10, following the flash crash, but two days later the market topped out right at the 50-day moving average, and went straight down.

So the big question is, whether this is going to be a bounce like we saw during the rally -- when we went straight up on light volume -- or is it going to be more like the failed bounce that occurred after the market turned down in April?

There have been plenty of buyers over the last few weeks who would be happy to escape some positions as they move back to even, and the bears are going to be looking for new entries fairly soon -- especially since volume was light.

I think we could run to 1070-1075, but the really big hurdle comes at 1100, and that is where the bears will likely become very aggressive -- if we make it that far.

I continue to have confidence that we have seen the lows. We went down too far too fast, and that finally resulted in the reflexive bounce that we had today. If we make it back to 1100, then we can talk, but at this juncture, we should simply enjoy the bounce.

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